rate

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


fifo accountingdefinition of closing entriesoverhead cost per unitexample of accounting worksheetrecording prepaid expensespv bond calculator200 declining balance formulajournal entries under perpetual inventory systemaccrual adjusting entries examplesimportance of journal entries in accountingsample accounting worksheetis utilities a fixed costjournalizing transactions accountingdecentralisation in managementliabilities equationcalculate federal witholdingwhat is the formula for total variable costinfocus payrollbad debts allowance methodjournalizing and posting closing entriesjournal entry for accounts receivablebond premiums and discountsprepare the journal entries to record this transactionhow to calculate ss tax withheldwashington state payroll calculatorlist of overhead expensesreconciling the bank statementdell tag transferabsorption costing and variable costingdefinition of normal balanceapplied manufacturing overheadowners equity accountingmanufacturing overhead allocated formulaprepaid expense examplescalculate variable costs per unitinterest bearing note payableallocation base for manufacturing overheadaccounts receivable formulais accounts payable a credit or debitsales to investment ratioexample of retained earnings statementcontra assetmanagerial costingwip calculationhow to compute straight line depreciationsimple bank reconciliation templatehow to calculate fixed expensescontribution margin per direct labor hour formulafavorable variancestreasury stock journal entriesdepreciation cost per unitman hour calculation formulahow to calculate manufacturing overhead costaccounting matching principlevariable costing approachbad debt expense calculationjournal entry for paying salariestreatment of prepaid expensesdividend income journal entrysales margin variancefull accounting equationreturn on operating assets formulagaap income statement formatpayroll calculator nhjournal entries debits and creditsgross up payroll formulaexpenses to sales ratioprepaid expenses examplespv of an annuitysalvage value in accountingsalvage value calculationeffects of transactions on the accounting equationcontra liability account examplespayroll accrual journal entryhow to calculate the cost of direct materials usedjob costing service industrytrial balance and balance sheet examplepayroll payable journal entry