Calculating Interest when Recording Accounts Receivable

All right, how to calculate interest

And this is like I said, this is a pretty important one because you need to know how to calculate it correctly in order to make the journal issues accurate

So first and foremost, we need to talk about the conceptual stuff

So in order to calculate the interest, it's the principle of the note, that's what you start with, times the annual interest rate

Typically when you're given percentage rates on your problems of stuff, these are what we call APRs or annual percentage rates

So they're based under the assumption of 12 months. Even if the note is not 12 months, they're going to give it to you in terms of 12 months

So that's what this last piece where it says times the time expressed in years, that's putting it in terms of a proportion of the year that you're actually going to be using this

or it's actually four. You'll understand what I mean by that when we do the examples here in a second

It is important, though, that if the days, if the time period of maturity date is given to you in days

so it's like a 90-day note, it is important that you understand that a year for us

we assume has 360 days for the purpose of computing interest that makes the fractions a whole lot more likable and not having to do any crazy decimal So if it 90 days then we would assume it 90 out of 360 rather than 90 out of 365 Again it just makes the

decimals a little bit easier to handle. So let's look, I'm going to give you three examples just

of what you could see and how we calculate this. So first and foremost, the first one, a one-year

note for $50,000 with a 6% interest beginning March 1st. Okay, so first we're going to start

with the principal. So again, principle times, a principal amount, times the interest rate

times the year in terms of year expressed in fraction of a year, time expressed in the fraction of year

That's going to give me my interest, total interest. So let's put these numbers in there. What's my

principal amount? Well, it's 50,000. What is my interest rate? We're at 6%. And what does this

mean when it says time expressed in the fraction of a year? Well, this is a one-year note

and this is going to seem really redundant to you. But if you get a the practice of doing it, it just makes things easier so you won't forget

This is a one-year note or a 12-month note. So what I want to do is I going to put this 12 months over 12 months because it is over the course of a year So that 6 that they gave us it is under the assumption of a year and this is a year So that why I put it 12 over 12

I know it looks weird right now, but just bear with me. And when I do this calculation, this is going to give me a total interest of $3,000

Okay. I know 12 of the 12 is 1, but just again, if you put it in practice and keep it in a system

you're less likely to forget it. Okay, so let's look at another example, okay

This one's a nine month note for $50,000 with a 6% interest beginning on July 1st, okay

We're at a nine month now, not a 12 month, so let's go through this again. So again, your equation is principal amount times the interest rate, times the time expressed

in a fraction of a year that gives you your income, or your total interest, excuse me

Principal amount is still 50,000, interest rate still 6%, but here's where it differs, okay

Because this is not a 12-month note, this is only a nine months

So we're only gonna be taking a portion of the 6%. So what we gonna do is we gonna divide it nine over 12 That why the last one I did 12 over 12 because it was a year But this one we gonna to do 9 over 12 We have to do that or we going to be charging myself too much And this is going to be or we going to receive them too much And that going to give me a

total interest of 20 to 50. I'm going to give you one more example of how to do this calculation

What happens if they give it to you in days? Just to kind of show you the other side. So what if it's a 90-day note for $50,000 at 6% interest on November 1st? So again, same thing

you still got your principal amount times your interest rate times your time expressed in a fraction of a year

it gives you your interest total interest so in principal amount is 50 000 interest rate is 6

but the time expressed in a fraction of year this time we're going to start with a numerator of

90 but we're going to divide it by that banker's rule of 360 and again it makes the the fraction

a little bit more palpable and by doing this calculation it will give me a total interest of

$750. So that's how you do just the calculations for the interest. In the next video

I'm going to show you how to do the entire example of interest in notes receivables. So that'll

give you a little bit more clarity. Appreciate it