Q17RQ - Horngren'S Financial And Managerial Accounting

Question

 How does compound interest differ from simple interest?

Step-by-Step Solution

Answer

Answer

Simple interest is calculated on principle only whereas compound interest is calculated on both the principal and the previously accrued interest.

Step 1: Meaning of Simple Interest

The cost of borrowing is known as simple interest. Borrowers will benefit from specific interest since they will only be charged interest on the advances they have taken out. In other words, simple interest is the sum paid to a borrower for using borrowed reserves over a set period.

Step 2: The difference between compound interest and simple interest.

The term "simple interest" alludes to interest computed fair on the principal. Compound interest, on the other hand, is computed on both the principal and all previously earned interest.

Compound interest is based on the presumption that the interest earned will be reinvested and helps to create additional interest at the same rate.