Formula to Calculate Interest Expense

Calculate Interest Expense (Step by Step)

#1 – Simple Interest Method

In the case of a simple interest method, the interest expense can be calculated by multiplying the outstanding principal, the annualized interest rate, and the number of years. Mathematically, it is represented as,

where,

  • P = Outstanding principalt = Number of yearsr = Annualized rate of interest

For the simple interest method, the interest expense can be determined by using the following steps:

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Interest Expense Formula (wallstreetmojo.com)

  • Firstly, determine the annualized rate of interest for the given debt level. The annualized interest rate is denoted by ‘r,’ which is clearly stated in the loan agreement. Next, determine the outstanding principal of the loan, i.e., the opening balance of the loan principal at the beginning of the year. It is denoted by ‘P,’ and can be confirmed from the company’s accounts department or the loan schedule. Next, figure out the tenure of the loan, i.e., no. of years remaining till maturity. The tenure of the loan is denoted by ‘t’ and is available in the loan agreement. Finally, in the case of the simple interest method, the interest expense during a period can be calculated using the formula, Interest expenseSI = P * t * r

#2 – Compound Interest Method

In the case of the compound interest method, the interest expense can be calculated based on the outstanding principal, the annualized interest rate, the number of years, and the no. of compounding per year. Mathematically, it is represented as,

  • P = Outstanding principalt = Number of yearsn = No. of compounding per yearr = Annualized rate of interest

For the compound interestCompound InterestCompound interest is the interest charged on the sum of the principal amount and the total interest amassed on it so far. It plays a crucial role in generating higher rewards from an investment.read more, the interest expense can be determined by using the following steps:

  • Step 1 to Step 3: Same as above.Step 4: Next, the no. of compounding periods per year is determined. Usually, the no. of compounding periods in a year can be 1 (annually), 2 (half-yearly), 4 (quarterly), etc. The number of compounding periods per year is denoted by ‘n.’Step 5: Finally, in the case of the simple interest method, the interest expense during a period can be calculated using the formula,

Interest expense CI = P * [(1 + r/n)t*n – 1]

Examples

Example #1

Let us take an example where the interest expense is calculated on a sum of $1,000 for one year with a simple interest of 12%.

  • Given, Principal, P = $1,000The rate of interest, r = 12%No. of years, t = 1 year

As per simple interest method, calculation of the interest expense will be,

= P * r * t

= $1,000 * 12% * 1

Example #2

Let us take an example where the interest expense is to be calculated on a sum of $1,000 for one year with an interest rate of 12% on the compounding method basis. The compounding is done:

  • DailyMonthlyQuarterlyHalf-yearlyAnnual

Given, Principal, P = $1,000

Rate of interest, r = 12%

No. of years, t = 1 year

Since daily compounding, therefore n = 365

As per compound interest method, the interest expense can be calculated as,

= P * [(1 + r/n)t*n – 1]

= $1,000 * [(1 + 12%/365)1*365 – 1]

= $127.47

Since monthly compounding, therefore n = 12

As per the compound interest method, the interest expense can be calculated as,

= $1,000 * [(1 + 12%/12)1*12 – 1]

= $126.83

Since quarterly compoundingQuarterly CompoundingThe compounding quarterly formula depicts the total interest an investor can earn on investment or financial product if the interest is payable quarterly and reinvested in the scheme. It considers the principal amount, quarterly compounded rate of interest and the number of periods for computation.read more, therefore n = 4

As per the compound interest method, calculation of interest expense will be,

= $1,000 * [(1 + 12%/4)1*4 – 1]

= $125.51

Since half yearly compounding, therefore n = 2

= $1,000 * [(1 + 12%/2)1*2 – 1]

= $123.60

Since annual compounding, therefore n = 1,

= $1,000 * [(1 + 12%/1)1*1 – 1]

= $120.00

From the above results, it can be inferred that all other factors being equal, the simple interest method and compound interest method yield equal interest expense if the no. of compounding per year is one. Further, under the compound interest method, the interest expense increases with the increase in the number of compounding per year.

The Below table provides the detailed calculation of the interest expense for various compounding periods.

The below graph shows the Interest ExpenseInterest ExpenseInterest expense is the amount of interest payable on any borrowings, such as loans, bonds, or other lines of credit, and the costs associated with it are shown on the income statement as interest expense.read more for various compounding periods.

Relevance and Uses

This has been a guide to the Interest Expense Formula. Here we discuss how to calculate Interest expenses using two different methods, i.e., the simple interest method and compound interest method, along with practical examples and a downloadable excel template. You may learn more about Accounting from the following articles –

  • Compound Interest ExamplesCompound Interest ExamplesTo calculate the compound interest in excel, the user can use the FV function and return the future value of an investment. To configure the function, the user must enter a rate, periods (time), the periodic payment, the present value. Compound interest formula = FV(rate,nper,pmt,pv)read moreDaily Compound InterestDaily Compound InterestDaily Compound Interest refers to the total interest amount, including the amount of interest earned on the initial principal & the amount of interest earned daily. It might be higher than Monthly or Quarterly Compound Interest due to the high compounding frequency. read moreNominal Interest RateNominal Interest RateNominal Interest rate refers to the interest rate without the adjustment of inflation. It is a short term interest rate which is used by the central banks to issue loans.read moreInflation vs. Interest Rate