simple interest calculation

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

prepaid insurance adjusting entry examplescash accounting balance sheethow to use lifo methodpv annuity due tableprepaid expense exampleadjusting entries example problemsaccounting for asset purchaseequity accounts on balance sheetwhat is office supplies expense in accountingcogs reductionmeaning of job costingallocation of factory overheadmanufacturing cogsdefine average variable costdeposit in transit bank reconciliationtips for studying accountingcost accounting varianceshow to calculate overhead cost formulasalvage value calculatorcalculate how much federal tax should be withhelddirect labor definitionunearned revenue on a balance sheetsalary expense journal entrybad debt journal entrycontribution margin per direct labor hourcompute the weighted average cost of capitalstate and federal unemployment taxesbonds accrued interestfavourable variancejournalizing accounting exampletime value of money tables present valuecalculate present value of annuitycost of goods sold fifojob cost sheet templateformula for total asset turnoverjournal entry for accrualsretained earning balancegross up paycheck calculatorsegmented bowl calculatorcalculating present value of annuityjob costing questions and answersfifo stock salesthe adjusted trial balance is preparedbank reconciliation outstanding checksconvert net pay to grossjournal entry worksheet accountingprepayment double entryfreight in journal entryhow to prepare cash flow statement from trial balanceadjusted and unadjusted trial balanceperiodic inventory system and perpetual inventory systemcredit sales on balance sheetjournal entries of accounts payableaccounting for factory overheadwhat is lifo and fifoprepare a retained earnings statementabsoption costingdefine prepaid insurancejournal entry for reserve for bad debtswhat is the purpose of the post closing trial balancereceivables agingknight company reports the following costs and expenses in maycogs accountingbank recfixed expensehow to compute social security taxapplied manufacturing overhead formulaprepare a statement of cost of goods manufacturedcontribution margin ratiothe present value of an ordinary annuityexplain fixed and variable costs