Most interest calculations that you will encounter are simple interest calculations. In a simple interest calculation, interest is calculated for a defined period of time based on the outstanding balance. Simple interest is used for savings accounts, notes receivable, notes payable, bonds, student loans and lots of other applications. We will discuss how simple interest calculations apply to debt, but the methodology is the same for other applications.


The amount of interest charged on a loan is based on three factors: principal, interest rate and time.

Principal is the outstanding balance on a loan. As a loan is paid down, the principal balance decreases. Therefore the interest on the loan also decreases. If the monthly payment on the loan is an equal amount each month, over time, less of the payment will go to interest and more to the principal balance.

The interest rate is the amount of interest charged on the loan. Typically, interest is expressed as an annual percentage rate, also called APR. Although interest is expressed as an annual rate, most loans charge interest monthly. To calculate the monthly rate, divide the annual interest rate by 12.

Time is the duration over which the interest is accruing. If interest is charged monthly, typically we would use the number of days the month divided by 360. Yes, I know there are 365 days in a year, but before calculators and computers, it was much easier to calculate based on 360 days. This became the tradition even after the invention of calculators because banks found they would earn more interest on outstanding debt using 360. Pretty sneaky, huh?

To calculate the amount of interest on a loan, we use this formula:

Interest = P*R*T or Principal * Rate * Time


On February 1, Technorama borrows $10,000 from the bank on a 8%, 90-day note with interest due at the time of repayment. How much cash will Technorama need to pay off the note when it comes due?

First, we need to identify our PRT. Principal is the amount borrowed, $10,000. The rate is 8%. Remember that rates are expressed as an annual rate even though the loan is only for 90 days. The duration of the loan, time, is 90 days. Now we can set up our formula.

Interest = $10,000 * 8% * 90/360

Interest = $200

The question asks how much cash will be required to pay off the note. $200 is not the answer. To pay off the note, Technorama must pay the interest and the principal. Therefore, the cash required is $10,200.

When doing simple interest calculations, just remember PRT. Always use the annual rate and multiply it by the amount of time for which you are calculating the interest.

Share This:

Related pages

how to calculate ending retained earningsoffice supplies accounting definitionifrs matching principleifrs warranty revenue recognitionbenefit of activity based costingjournal entries for accounts receivable processaccounts payable adjusting entryaging of accounts receivable methodaccrued interest bondstotal variable cost formulahow to compute social security taxretained incomenpv tableshow to calculate discontinued operationsnsf check bank reconciliationcontra invoice definitionfifo cost formulaabsorption based costingaccum depreciationwhat accounts have a normal debit balancecogs costincome statement from trial balancevariable costing exampleordinary annuity present valuejob order costing t accountsaccount payable journal entrytotal variable cost graphtypes of depreciationsdifficult accounting entrieswhat is a selling expensejob order costing system exampleexamples of accounts receivableretained earning statement examplejournal entry for provision for expenseswhat is federal withholding tax ratedepreciation cost calculatordeclining depreciation methoddisposal of asset journal entrypohr accountingprepare an unadjusted trial balancereceivables aging schedulevariance formula financegaap managerial accountingtrial balance items included trial balancedefinition of profit centreunearned revenue accountaccounting treatment for disposal of fixed assetsaccrued wages balance sheetpv discount factorvariable and fixed expensesjournal entry of provision for doubtful debtsjournal entry for withholding taxdirect material formulafifo costingtotal variable cost equationmeaning of unearned incomeaccounting for merchandise inventoryaccounts receivable journal entriesmerchandise inventory formulaexample of adjusting entryprepaid expenses journal entry examplecalculate interest expense on loansample trial balance worksheethow to calculate profit margin in accountingreconciled balance definitionshare based payments journal entriesapplying manufacturing overheadfour closing journal entriesjournal entries for accounts payableexample of lifo and fifosales tax payable journal entryuncollect hold checktabel present value annuityformula of cost of good soldlist of accounts with their balances