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Editorial Board on Accounts and Audit
  • Effective interest rate

    by Chirag on Sunday, June 09, 2019 at 01:35 AM

    A Co. borrowed Rs. 10,00,000 from a bank who has charged Rs. 91,760 as the processing charges. The coupon interest rate is 12% and the loan is repayable in 5 years in equal installments of Rs. 2,77,410. Query- While calculating effective interest rate we will, 277410 multiply by PVAF (x%, 5 yrs) IS EQUAL TO 908240. I think,as we will REPAY 10 LACS IN THE 5TH YEAR,SO WE SHOULD CONSIDER 10 LACS AMOUNT IN 5TH YEAR while calculating effective interest rate. AM I RIGHT SIR? PLs clarify

    Replied byEditorial Board Thursday, June 13, 2019 at 08:46 PM

    For a financial liability, the effective interest rate is defined as the rate at which the present value of estimated future cash payments through the expected life of the liability equal to the initially recognised carrying amount of the liability. The cash payments are estimated considering all contractual terms of the financial liability.

    In your case, the company has borrowed Rs. 10,00,000 from a bank who has charged Rs. 91,760 as the processing charges. Here, the loan shall be recorded initially at its fair value, i.e., Rs. 9,08,240. Therefore, the effective interest rate shall be calculated in same manner as you have explained in the question.

 
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