##### Accounting

When you borrow money, and the interest is charged more often than annually, this is called compounding. As a result, the effective interest rate will be more than the annual rate.

The following practice questions require you to calculate the effective rate of loans where the interest is compounded quarterly.

## Practice questions

Use the following information to answer the questions.

Travel Fridge, Inc. borrows \$45,000 from the bank for one year at an annual rate of 8% compounded quarterly.

1. How much interest will the company pay on this loan?

2. What is the effective rate of the loan?

## Answers and explanations

1. \$3,709.45

If the interest is compounded quarterly, then interest is charged at the rate of 2% every 3 months. And, the unpaid interest is added to the principal.

First 3 months:

in interest is added to the principal.

Second 3 months:

in interest is added to the principal.

Third 3 months:

in interest is added to the principal.

Fourth 3 months:

in interest is due.

2. 8.243%

The effective rate is equal to the interest actually paid divided by the principal. If the interest is compounded quarterly, then interest is charged at the rate of 2% every 3 months. And, the unpaid interest is added to the principal.

First 3 months:

in interest is added to the principal.

Second 3 months:

in interest is added to the principal.

Third 3 months:

in interest is added to the principal.

Fourth 3 months:

in interest is due.

total interest paid.

or 8.243%

If you need more practice on this and other topics from your accounting course, visit Dummies.com to purchase Accounting For Dummies! Featuring the latest information on accounting methods and standards, the information in Accounting For Dummies is valuable for anyone studying or working in the fields of accounting or finance.

### About the book authors:

Kenneth Boyd is the owner of St. Louis Test Preparation (www.stltest.net). He provides online tutoring in accounting and finance. Kenneth has worked as a CPA, Auditor, Tax Preparer, and College Professor. He is the author of CPA Exam For Dummies. Kate Mooney has been teaching accounting to both undergraduates and MBA students at St. Cloud State University since 1986, after earning her PhD from Texas A & M University. She is a licensed CPA in Minnesota and is a member of the State Board of Accountancy.