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

budgeted income statementa debit balance in the allowance for doubtful accountsincome statement merchandisingtarget costing vs traditional costingoverhead costing methodstraditional absorption costing examplewhat is the journal entry for accrued expensesanother word for discontinuedallowance method journal entryhow to record payroll journal entrieshow do you calculate total variable costretained profit balance sheetp&l productionexample of journalizing in accountingjournal entry for bad debtswhat is adjusted balancewhat is the meaning of retained earningsentry for salary payabletreatment of under and over absorption of overheadsallowance for uncollectible accounts journal entryhow to get the ending inventoryadjusting journal entries accountingcost of goods sold chart of accountsdebit accounts payableaccounting inventory systemspreparing journal entries examplesraw materials turnoverincome statement for the month endedcalculate depreciation straight linepv factor chartannuity table for present valuestraight line depreciation examplesnormal balance of dividendsdouble declining balance method depreciationcontribution margin ratio formulafixed assets accounting entriescredit entry to accounts receivablereconciling itemcontra account exampleincome statement periodic inventory systemprice sales ratio definitionman hour cost calculationexpense account normal balancefinding the slope calculatorjournal entry for salary paid to employeesnet pay calculator with overtimeformula to find fixed costwhat type of account is allowance for doubtful accountsdollar value lifo method calculatorjournal entry bad debt expensewip balancejournal entry for depreciationestimate bad debt expensewhat is straight line amortizationwhat is variable expenses examplespayroll accounting textbookexamples of liabilities accountsdepreciation straight line method example problemsthe final step in the accounting cycle is to prepareincome statement defexamples of overhead expensesrevenue minus cost of goods soldhow to calculate labour rate per hourtrial balance calculatordebit credit journal entriesexample of an accelerated depreciation methoddirect write off method and allowance methodfifo and lifo for dummiescost of goods sold to sales ratioaccumulated depreciation expensedirect labor and indirect laborstraight line method depreciation calculatorabsorption costing calculationcost of good sold ratio