Interest Calculation and Basic Bank Accounting
Interest Calculation and Basic Bank Accounting
This domain tests simple and compound interest, EMI logic, day-count conventions and the debit–credit rules used in bank books. Expect numerical items and journal-entry questions.
Core rules
- Simple interest = P × R × T / 100. Compound interest = P(1 + R/100)^T − P.
- Banks usually calculate savings interest on the daily balance and credit it quarterly; the convention is a 365-day year.
- Flat rate versus reducing balance: a flat rate charges interest on the original principal throughout; a reducing-balance rate charges on the outstanding balance.
- EMI = P × r × (1 + r)^n / [(1 + r)^n − 1], where r is the monthly rate and n is the number of months.
- Golden rules: debit the receiver, credit the giver; for real accounts debit what comes in and credit what goes out; for nominal accounts debit expenses and losses and credit incomes and gains.
- In the bank's books, customer deposits are liabilities and carry credit balances; advances are assets and carry debit balances.
- Interest income is a nominal credit; interest expense is a nominal debit.
Worked example
A loan of ₹1,00,000 at 12% p.a. reducing balance is repaid in 12 monthly instalments. Monthly r = 1%. (1.01)^12 = 1.126825. EMI = 100000 × 0.01 × 1.126825 / 0.126825 = ₹8,884.88. Total payment is ₹1,06,618.56, so interest is about ₹6,618.56. A flat 12% quote would suggest ₹12,000 interest, which is why the basis must be stated.
Traps
- Flat and reducing-balance rates are not comparable.
- EMI includes principal repayment; it is not all interest.
- A deposit is a credit in the customer's passbook and a liability in the bank's balance sheet.
- Interest calculation on 360 days versus 365 days changes the answer.
- Do not debit a nominal income account.