**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 |