notes receivable

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.

PRT

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

Example:

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


accounting income summaryjournal entry for advance salary paidallocation of overheadstrade receivables formulacorrecting entry accountinglifo method perpetual inventory systemcogs includesfifo calculation formulawhere does accrued interest go on the balance sheetfinancial accounting journal entry examplesassets liabilities equity equationcost of goods available for sale formulawhat is fifo in accountingwhat does depreciate meanmanufacturing overhead cost calculationstock average down calculatordefinition of job costingbookkeeping journal entriesfica medicare tax rate 2014purchase returns and allowances journal entrytraditional income statement managerial accounting exampleabsorption costing versus variable costingretained earnings cash flow statementcogs reductionhow to calculate fica taxesexample of closing entriesabsoprtion costingfixed cost and variable cost examples for manufacturinghow to calculate cost of goods available for salecash discount journal entrymerchandise inventory accountinghow long to cash in premium bondsjournal entry bad debt expensehow to compute ending inventorydeclining balance method formulaunadjusted trial balance exampledebited and creditedperiodic lifoproduct costing formulaformula for total asset turnover ratioaccount receivable aginghow is fica calculatedcompute take home payhow to calculate variable expenses per unitamortized bondwrite off bad debts meaningadjusting entries for prepaid expensesannuity factor tablepresent worth factor tableinvestment accounting journal entriesinventory turnover calculator onlinegeneral journal adjusting entriesar accounting entriesretained earning accountingwhy are inventories included in the computation of net incomethe balance in premium on bonds payablewhat is gross wages meansalvage value equationfixed cost per unit increases whenhow to calculate straight line depreciation ratejournal entry for provision for expenseshow to find annual depreciation ratewip inventory definitionaccrual journal entriesexplain absorption costinghow to calculate factory overhead rateaccrued salaries journal entrya federal unemployment tax is levied onpv factor calculatorcalculate fica withholdingfifo method accountingmaker taker pricing3 examples of fixed expenseshow to calculate contribution margin percentage