We switched bookkeeping software last year and are busy this weekend putting last year to bed. In past years our CPA tracked the loans my partner and I have made to the business, but we’re doing that now. I’ve looking at what the CPA had done in the past and it seems he’s taken whatever the amount owed was at the start of a year, calculated interest and then deducted payments. That’s fine, I guess.
But I noticed one year he compounded the interest after seven months, that month being one when we paid off a loan to my partner. He then used that seven month compounded figure to calculate interest on my loan for the remaining five months of the year.
These are sweetheart loans where we’re charging the minimum allowable interest. Are there any hard and fast rules about how often one can, may or must compound interest?
As far as I know, compounding (as well as the interest rates – within limits) is determined by the person or institution making the loan or paying into the account. You don’t have to compound interest, or you can compound continuously (i.e., an infinite number of times, which can be done with a simple mathematical formula) or anything in between. There may be a contract, or there may not.
The more times you compound, the higher the interest rises, but the rate of increase slows so that the difference between daily and continuous compounding isn’t all that much.
“East is east and west is west and if you take cranberries and stew them like applesauce they taste much more like prunes than rhubarb does.” – Marx