The formula to calculate interest expense are of two types – the first method is called as simple interest method in which interest expense is calculated by multiplying principal outstanding, rate of interest and the total number of years and the second method is called as compound interest method where interest amount is calculated by the way of multiplying principal by one plus annual rate of interest raised to number of the compound period less one and lastly resultant value is deducted from total initial amount.

**Table of Contents**

## What is Interest Expense Formula?

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

**Interest Expense Formula**

_{SI}= P * t * rwhere,

- P = Outstanding principal
- t = Number of years
- r = Annualized rate of interest

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

**Interest Expense Formula**

_{CI}= P * [(1 + r/n)^{t*n}– 1]where,

- P = Outstanding principal
- t = Number of years
- n = No. of compounding per year
- r = Annualized rate of interest

### Explanation of the Interest Expense Formula

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

**Step 1:** Firstly, determine the annualized rate of interest for the given debt level. The annualized rate of interest is denoted by ‘r’ and it is clearly stated in the loan agreement.

**Step 2:** 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 it can be confirmed from the accounts department of the company or the loan schedule.

**Step 3:** 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.

**Step 4:** Finally, in case of simple interest method, the interest expense during a period can be calculated using the formula as,

**Interest expense _{SI} = P * t * r**

For the compound interest method, the formula for 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 case of simple interest method, the interest expense during a period can be calculated using the formula as,

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

### Examples of Interest Expense Formula

Let’s see some simple to advanced examples for the calculation of Interest Expense Equation to understand it better.

#### Interest Expense Formula – Example #1

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

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

Below is data for calculation of interest expense as per simple interest method,

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

Interest Expense = P * r * t

= $1,000 * 12% * 1

Interest Expense = **$120.00**

#### Interest Expense Formula Example #2 (with Excel Template)

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

**Daily****Monthly****Quarterly****Half yearly****Annual**

Given, Principal, P = $1,000

Rate of interest, r = 12%

No. of years, t = 1 year

**#1 – Daily Compounding**

Since daily compounding, therefore n = 365

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

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

- Interest expense= $1,000 * [(1 + 12%/365)
^{1*365}– 1] - Interest expense = $127.47

**#2 – Monthly Compounding**

Since monthly compounding, therefore n = 12

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

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

- Interest expense= $1,000 * [(1 + 12%/12)
^{1*12}– 1] - Interest expense = $126.83

**#3 – Quarterly Compounding**

Since quarterly compounding, therefore n = 4

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

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

- Interest expense= $1,000 * [(1 + 12%/4)
^{1*4}– 1] - Interest expense = $125.51

**#4 – Half Yearly Compounding**

Since half yearly compounding, therefore n = 2

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

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

- Interest expense= $1,000 * [(1 + 12%/2)
^{1*2}– 1] - Interest expense = $123.60

**#5 – Annual Compounding**

Since annual compounding, therefore n = 1,

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

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

- Interest expense= $1,000 * [(1 + 12%/1)
^{1*1}– 1] - Interest expense = $120.00

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

### Relevance and Uses of Interest Expense Formula

From a borrower’s point of view, it is important to understand the concept of interest expense since it is the cost incurred by the entity for borrowed funds. The interest expense is a line item that is captured in the income statement as a non-operating expense. It denotes the interest to be paid on the borrowings – which may include corporate loans, bonds, convertible debt or other similar lines of credit. The significance of interest expense further increases because it is tax deductible for both companies and individual in most countries. Therefore, it is vital to understand the interest expense of a company as it would help in understanding its capital structure and financial performance.

### Recommended Articles

This has been a guide to Interest Expense Formula. Here we discuss how to calculate Interest Expense along with practical examples and downloadable excel template. You may learn more about Accounting from the following articles –

- Quarterly Compounding Formula
- Compound Interest Examples
- Monthly Compound Interest Formula | Examples
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- Examples of Daily Compound Interest Calculation (with Excel Template)
- Applications of Nominal Interest Rate
- Nominal Interest Rate Formula
- Inflation vs Interest Rate – Compare
- Formula of Interest Rate
- What is Real Interest Rate?