Page 51 - Account for Ag - 2019

CH 9] Accounting for Notes & Interest 9-3

CALCULATING INTEREST

A simple formula provides the answer for any PRINCIPAL amount of money at any RATE interest, for any
length of TIME. The basic formula for calculating INTEREST is:

PRINCIPAL x RATE x TIME = INTEREST

For example, if the amount of money borrowed, known as the PRINCIPAL, is $400.00, and it is borrowed
for 3 months at a rate of 12% interest, the computation is as follows, using the above formula:

PRINCIPAL x RATE x TIME = INTEREST

$400.00 x 12/100 x 3/12 = $12.00

If the maturity time is expressed in terms of days, such as 90 days or 120 days, the formula is slightly
changed:

P x R x T = I
Principal x Rate of Interest x Number of Days = Interest
100 360

A slightly different manner of computing interest is to express the rate as a decimal, instead of as a fraction.
Thus, 6% is 0.06; 5-1/2% is 0.055; 6-1/4% is 0.0625. If the rate of interest is expressed as a decimal, this
amount is multiplied by the principal, and the result is then multiplied by the "time" fraction.

Rates of interest are usually stated in terms of a period of one year. Thus, the interest on a $1,600, 1-year,
8% note would amount to 8% of $1,600, or $128. If instead of one year, the term of the note was half of a year,
then the interest would amount to one-half of $128, or $64.

Notes covering a period of time longer than a year ordinarily provide that the interest be paid annually,
semiannually, or at some other stated interval. The time involved in commercial credit transactions is usually
less than a year, and the interest provided for by the note is payable at the time the note is paid. In computing
interest for a period of less than a year, agencies of the federal government use the actual number of days in the
year; for example, 90 days is considered to be 90/365 of a year. As a means of simplifying the calculation, the
usual commercial practice is to use 360 as the denominator of the fraction; thus 90 days is considered to be
90/360 of a year. The commercial practice will be followed in this book.

To illustrate the application of the formula, assume a note for $1,500, payable 15 days from date, with
interest at 8%. The interest would be $5.00, computed as follows:

$1,500 x .08 x 15/360 = $5.00 interest

Notes Payable
All notes payable are usually recorded in one account in the general ledger. The details of each note issued
are kept by preparing a carbon copy at the time the note form is filled in or by maintaining some other type of
supplementary record. For this reason there is usually no advantage in maintaining a subsidiary ledger for notes
payable.

When a note is issued to a creditor in payment of an account, the liability Accounts Payable is decreased
and the liability Notes Payable is increased. These facts are recorded by debiting the accounts payable account
and the account of the creditor to whom the note was issued, and by crediting the notes payable account.
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