How much does a one-off fee increase the real cost of a loan?
A 24 percent loan can turn out more expensive than a 25 percent one if a fee is deducted from it up front. The rule for calculating the real cost, a comparison of two banks' offers and the journal entries.
When comparing loan offers, most people look only at the interest rate. But if a one-off fee is also charged together with the loan, the real cost of the debt is higher than the advertised rate.
Key points
- Real cost = (interest for the period + fee) / amount actually received. This is a simple calculation that ignores the time value of money, but it is enough for comparison
- If the fee is deducted from the loan amount while interest is charged on the full amount, you receive less money but the interest does not decrease: the cost rises from both sides
- The shorter the loan term, the greater the effect of a one-off fee. Over a long term it is "spread" across the years
- NAS No. 24 defines borrowing costs as "interest and other costs" incurred in connection with obtaining borrowed funds (paragraph 3)
- Borrowing costs that are not capitalised are recognised as an expense from financial activities (NAS No. 24, paragraph 9). Loan interest is accrued with the entry Dt 9610 – Ct 6920 (NAS No. 21, paragraph 427, line 1)
- Compare offers under the same conditions: the same amount, the same term, the same repayment schedule
Example: two banks' offers
The rates are hypothetical. "Yashil Vodiy" LLC needs 100 000 000 soum for 1 year. Interest is paid monthly, and the principal is repaid in a single payment at the end of the year.
| Indicator | Bank A | Bank B |
|---|---|---|
| Annual rate | 24% | 25% |
| Fee (deducted from the loan amount) | 2% = 2 000 000 | None |
| Amount received | 98 000 000 | 100 000 000 |
| Interest for one year | 24 000 000 | 25 000 000 |
| Total cost | 26 000 000 | 25 000 000 |
| Real cost | 26 000 000 / 98 000 000 = 26.53% | 25 000 000 / 100 000 000 = 25% |
Bank A, which looks "cheap", is actually more expensive. If the term is 2 years: at bank A the cost is 48 000 000 + 2 000 000 = 50 000 000 soum, or 25 000 000 / 98 000 000 = 25.51% a year. The difference narrows, but bank B is still the better option.
If bank A is chosen, interest is accrued every month:
| Transaction | Debit | Credit | Amount |
|---|---|---|---|
| Monthly interest accrued (24 000 000 / 12) | 9610 | 6920 | 2 000 000 |
Which expense account should reflect the deducted fee is not shown separately in the sample entries of NAS No. 21. Set out the procedure for it in your accounting policy and do not change it during the year.
Test yourself
5 questions on this topic: pick an option or reveal the answer.
An entrepreneur took a bank loan of 10 000 000 soum: 1 year, 20% simple annual interest, interest and principal paid at the end of the year. When issuing the loan the bank immediately withheld a one-off fee of 2% of the amount (hypothetical terms). What is the approximate effective annual cost of the loan relative to the money actually received?
The bank lent "Tomdi tikuv" LLC 60 000 000 soum for 45 days. Under the contract the annual rate is 18% and a year is taken as 360 days for interest calculation (hypothetical terms). What is the amount of interest accrued on the loan?
A hypothetical commercial bank has loans to customers of 840 bln soums and customer deposits of 1 050 bln soums. What is the loan-to-deposit ratio (loans / deposits × 100%)?
"Asaka avtoqism" LLC assigned a buyer's receivable of 50 000 000 soum to a bank under a factoring agreement. The bank immediately pays 80% of the receivable and withholds a fee of 2% of the receivable (hypothetical terms). How much money does the company receive immediately?
According to the bank statement, account 5110 "Settlement account" had an opening balance of 15 000 000 soums at the start of the month, debit turnover during the month of 40 000 000 soums and credit turnover of 32 000 000 soums. What is the closing balance at month-end?
Answered: 0 / 50 of 5 correct
All tests →See also
Sources
- NAS No. 24 "Accounting for Borrowing Costs", paragraphs 3 and 9 · borrowing costs: interest and other costs incurred in connection with obtaining borrowed funds; the part that is not capitalised is recognised as a period expense (expense from financial activities)
- NAS No. 21 "Chart of Accounts", paragraphs 423 and 427 (paragraph 427, line 1) · accrual of interest on loans and borrowings 9610 / 6920
- Example, interest rates and calculations · compiled by the author, hypothetical