Simple and Compound Interest Methods

http://accountinginfo.com/study/pv/interest-101.htm

Simple and Compound Interest Methods

Simple Interest
      Interest = Principal x Interest rate per period x Number of periods

Compound Interest
      Interests for previous periods are added to principal for the calculation of interest.
      Interest for the n^th period
          = (Principal + Interest for period 1 +  .... + Interest for period n-1) x Interest rate per period


[Example 1, Company A]

Company A borrowed $200,000 on January 1, 2011.  Annual interest rate is 10%.  Calculate interest expenses for 2011, 2012 and 2013.

Simple Interest Method

Year	Principal	Interest rate	Interest expense	Principal + Cumulative interest
2011	$200,000	10%	$20,000 (*1)	$220,000
2012	$200,000	10%	$20,000 (*1)	$240,000
2013	$200,000	10%	$20,000 (*1)	$260,000

   (*1) $200,000 x 10% = $20,000

Compound Interest Method
   Interest is compounded annually.

Year	Principal	Interest rate	Interest expense	Principal + Cumulative interest
2011	$200,000	10%	$20,000 (*2)	$220,000
2012	$200,000	10%	$22,000 (*3)	$242,000
2013	$200,000	10%	$24,200 (*4)	$266,200

   (*2) $200,000 x 10% = $20,000
   (*3) $220,000 x 10% = $22,000
   (*4) $242,000 x 10% = $24,200

Interest Calculation Example 1
Interest Calculation Example 1a

Interest Calculation Example 2
Interest Calculation Example 2a

Compound Interest Example 1
Compound Interest Example 2