A bank statement line marked “charges” or “interest” can belong in three different places. In the Companies Act profit and loss formats, interest paid and interest earned have their own lines below operating profit, while the cost of running a bank account is an ordinary operating expense. Lenders, investors and anyone reading your management accounts look at operating profit before finance costs, so a loan’s interest posted to bank charges makes the business look less profitable than it is, and a bank’s monthly fee posted to interest does the reverse.
The three accounts
| Account | Typical contents | Profit and loss heading |
|---|---|---|
| Bank charges | Monthly account fees, per-transaction charges, CHAPS and international payment fees, unpaid item charges | Administrative expenses (above operating profit) |
| Interest payable | Loan and overdraft interest, hire purchase interest, interest on late tax | Interest payable and similar expenses |
| Interest receivable | Interest on savings and deposit accounts, interest charged to customers for late payment | Other interest receivable and similar income |
Card processing fees from a merchant provider are bank-like but are better in their own account, because they move with sales rather than with banking; see bank charges and interest in bookkeeping. Overdraft arrangement fees are a cost of borrowing and sit more naturally with interest payable than with bank charges.
Posting a month’s bank statement
A current account statement for March shows a £18.00 account fee, £6.50 of payment charges, £42.17 of overdraft interest, and £11.23 of interest credited to the linked savings account. The postings:
| Account | Debit | Credit |
|---|---|---|
| Bank charges | £24.50 | |
| Interest payable | £42.17 | |
| Current account | £66.67 | |
| Savings account | £11.23 | |
| Interest receivable | £11.23 |
Bank feed rules are useful here, but set one rule for each type of line rather than one rule for every line from the bank. A rule that sends everything containing “interest” to interest payable will also catch savings interest received.
VAT on bank charges and interest
Most charges for operating a bank account, and all interest, are exempt from VAT. No VAT is charged, so there is nothing to reclaim. Post these lines with your software’s exempt or no-VAT code; using the standard rate code would invent input VAT that never existed. Occasionally a bank or finance provider charges VAT on a particular service, in which case it will appear on an invoice or statement as VAT. Use what the document shows rather than guessing.
Interest you receive from your bank is not a sale on which you charge VAT.
Interest you charge customers who pay late
Business-to-business customers who pay late can be charged statutory interest under the Late Payment of Commercial Debts (Interest) Act 1998, unless your contract sets a different rate. The statutory rate is 8% above the Bank of England base rate. You can also claim a fixed sum towards collection costs, which increases with the size of the debt. The current rules are on GOV.UK’s guide to charging interest on a late commercial payment.
As an illustration only: if base rate were 4%, the rate would be 12% a year. An invoice of £4,800 paid 60 days late would carry interest of £4,800 × 12% × 60 ÷ 365 = £94.68.
Record it only when you invoice it, and only if you expect to collect it. Statutory interest is compensation rather than payment for a supply, so it is outside the scope of VAT:
| Account | Debit | Credit |
|---|---|---|
| Trade debtors | £94.68 | |
| Interest receivable | £94.68 |
If the customer refuses to pay the interest and you decide not to pursue it, reverse it against the same account rather than writing it off as a bad debt. Many businesses only charge late payment interest as leverage in the credit control routine, and drop it when the invoice is paid; that is a commercial choice, but either way the books should show only what is actually being claimed.
Interest and penalties from HMRC
HMRC charges interest on tax paid late and penalties for late returns or payments. Keep them apart. Interest goes to interest payable. Penalties are not deductible for tax and are best kept in a separate account so they can be added back easily; see fines and penalties. Neither belongs in the VAT or PAYE liability accounts, where it would make those balances disagree with HMRC’s statements.
Finer detail when you need it
A small business can manage with the three accounts above. Split them further only when the split answers a real question:
- Interest payable by facility, if you have several loans and want to see the cost of each.
- Interest receivable by source, separating bank interest from interest on loans you have made to others, such as a director.
- International payment charges, if you trade abroad and want to price them into quotes.
For the day-to-day routine of coding bank lines and checking them each month, see bank charges and interest in bookkeeping.