Question

On March 1, 20X4, Fine Co. borrowed $10,000 and signed a two-year note bearing interest at 12% per annum compounded annually. Interest is payable in full at maturity on February 28, 20X6. What amount should Fine report as a liability for accrued interest at December 31, 20X5?

Answer 1

$2,320

Step-by-step explanation:

the interest accrued by February 28, 20X5 = $10,000 x 12% = $1,200

since the interest compounds yearly, the interest accrued by December 31, 20X5 = ($11,200 x 12% x 10/12) + $1,200 = $1,120 + $1,200 = $2,320

Compound interest means that earned interest will earn more interest itself in the next period. That is why you need to include the previously accrued interest in the interest calculation for the second part.