Interest Calculation
Calculate interest on delayed payments, configure Tally's interest calculation feature, and record interest charged by suppliers
Prerequisites: Module 17 — Cash Discount
Learning Objectives
By the end of this module, you will be able to:
- Calculate simple interest on overdue payment amounts
- Distinguish between simple and compound interest
- Configure interest calculation in a Tally ledger
- Record interest charged by a supplier as an expense
Why Interest on Delayed Payment?
In commercial credit transactions, the credit period is an agreed commitment. When a buyer fails to pay within the agreed period, the seller loses the time value of money — effectively providing an interest-free loan to the buyer.
To compensate for this, suppliers often charge interest on overdue balances — a common practice in:
- Distributor-to-retailer credit (like TechWorld to Sunrise Retail)
- Bank overdrafts
- Financial institution loans
- Inter-company lending
The interest rate is usually specified in the credit terms or trade agreement.
How to Calculate Interest — Step by Step
Identify the overdue amount (Principal) This is the outstanding invoice balance that was not paid within the credit period. For Sunrise Retail's opening balance to TechWorld: ₹1,80,000.
Determine the rate and period Get the annual interest rate from the credit agreement (TechWorld: 18% p.a.) and count the exact days overdue (opening balance due March 31 → April 5 = 35 days).
Apply the simple interest formula
Interest = Principal × Rate × Days ÷ (100 × 365)
= ₹1,80,000 × 18 × 35 ÷ 36,500 = ₹3,107
Post the journal entry Dr Interest on Delayed Payment (expense) | Cr Supplier's A/c (increases liability) The overdue amount now becomes ₹1,80,000 + ₹3,107 = ₹1,83,107.
Pay in full and close the ledger Dr TechWorld Distributors ₹1,83,107 | Cr SBI Current Account ₹1,83,107
Simple Interest vs Compound Interest
Simple Interest
Interest is calculated on the original principal for the entire period. It does not accumulate on past interest.
Formula:
Compound Interest
Interest is calculated on the principal + accumulated interest from previous periods. Interest compounds — you pay interest on interest.
Formula (annual compounding):
In commercial B2B trade, simple interest is standard. Compound interest is typically used only in formal loans (banks, NBFCs).
Sunrise Retail — Case Study Application
💼 Sunrise Retail Pvt Ltd — Interest on Overdue Balance
Background
TechWorld Distributors charges 18% per annum simple interest on overdue amounts. The credit agreement specifies:
- Credit period: 30 days from invoice date
- After 30 days: 18% p.a. interest on outstanding balance
Sunrise Retail's opening balance to TechWorld was ₹1,80,000 (from March 2025 — assumed due March 31, 2025). By April 5, 2025, this is 35 days overdue (March 31 to April 5 = 35 days).
Calculation — Interest on Overdue Opening Balance
More precisely:
(The ₹3,112 figure in the module brief uses a slightly different day count — let's use ₹3,107 for precision.)
Journal Entry — Interest Charged by TechWorld:
| Account | Dr (₹) | Cr (₹) |
|---|---|---|
| Interest on Delayed Payment | 3,107 | |
| To TechWorld Distributors Pvt Ltd | 3,107 |
This increases the amount owed to TechWorld from ₹1,80,000 to ₹1,83,107.
After this, paying TechWorld in full:
| Account | Dr (₹) | Cr (₹) |
|---|---|---|
| TechWorld Distributors | 1,83,107 | |
| To SBI Current Account | 1,83,107 |
Second Scenario — Interest on April 5 Purchase (Overdue)
Suppose Sunrise Retail doesn't pay TechWorld's April 5 invoice (₹14,16,000) by the due date (May 5) and TechWorld charges interest for 10 days of delay (May 5 to May 15):
| Account | Dr (₹) | Cr (₹) |
|---|---|---|
| Interest on Delayed Payment | 6,984 | |
| To TechWorld Distributors | 6,984 |
Configuring Interest Calculation in Tally
Tally Prime has a built-in Interest Calculation feature that automatically computes and tracks interest on overdue balances. Once configured, Tally shows the interest accrued on any ledger in real time.
Enabling the Feature
Setting Interest on TechWorld's Ledger
Now, Tally will automatically calculate accruing interest on any overdue invoices in TechWorld's account. You can view this in:
The report shows:
| Invoice | Due Date | Amount | Days Overdue | Interest @ 18% p.a. |
|---|---|---|---|---|
| TW/001 | May 5 | ₹14,16,000 | 10 days | ₹6,984 |
Auto-Generating the Interest Journal Entry
From the Interest Report, press Alt+J to automatically post the interest as a journal entry — no manual calculation needed. Tally creates:
Interest Receivable — When Sunrise Retail Charges Interest
Sunrise Retail can also charge interest to overdue customers. If CloudStore's April 12 invoice (₹3,89,400, due May 12) is unpaid by May 25 (13 days overdue):
Journal Entry — Interest charged to CloudStore:
| Account | Dr (₹) | Cr (₹) |
|---|---|---|
| CloudStore Online Pvt Ltd | 2,497 | |
| To Interest Received | 2,497 |
CloudStore now owes: ₹3,89,400 + ₹2,497 = ₹3,91,897
Practice Exercise
Exercise 1: Sunrise Retail has an overdue balance of ₹5,00,000 to Galaxy Electronics. The invoice was due on June 1 and is being paid on June 22 (21 days late). Galaxy charges 15% p.a. simple interest.
Calculate the interest and write the journal entry.
Click to reveal solution
| Account | Dr (₹) | Cr (₹) |
|---|---|---|
| Interest on Delayed Payment | 4,315 | |
| To Galaxy Electronics | 4,315 |
Then when paying in full:
| Account | Dr (₹) | Cr (₹) |
|---|---|---|
| Galaxy Electronics | 5,04,315 | |
| To SBI Current Account | 5,04,315 |
Exercise 2: If the interest rate were 15% p.a. compounded monthly instead of simple, calculate the interest for the same ₹5,00,000 overdue for 2 months (approximately 60 days). Show the difference.
Click to reveal solution
Compound interest (monthly compounding, 2 periods): Monthly rate = 15%/12 = 1.25% per month
Amount = ₹5,00,000 × (1 + 1.25/100)^2 = ₹5,00,000 × (1.0125)^2 = ₹5,00,000 × 1.025156 = ₹5,12,578
Interest = ₹5,12,578 − ₹5,00,000 = ₹12,578
Simple interest for same period: 60 days at 15% p.a. = ₹5,00,000 × 15 × 60 / (100 × 365) = ₹45,00,000 / 36,500 = ₹12,329
Difference: ₹12,578 − ₹12,329 = ₹249 more under compound interest.
The longer the period, the larger the difference between simple and compound. For the same rate, compound is always more expensive for the borrower (and more beneficial for the lender) over time.
Key Terms
| Term | Meaning |
|---|---|
| Simple Interest | Interest calculated on original principal only — most common in trade |
| Compound Interest | Interest on principal + accumulated previous interest |
| Overdue | Payment not made within the agreed credit period |
| Interest on Delayed Payment | The charge for late payment — an expense in buyer's books, income in seller's |
| Interest Receivable | Interest owed to Sunrise Retail by late-paying customers — an asset |
| Interest Payable | Interest owed by Sunrise Retail to suppliers — a liability |
| Tally Interest Parameters | Configuration in ledger master to auto-calculate interest on overdue balances |
Module Summary
- Simple interest formula: Principal × Rate × Days ÷ (100 × 365)
- TechWorld charges 18% p.a. on Sunrise Retail's overdue ₹1,80,000 opening balance — 35 days overdue = ₹3,107
- Interest paid to supplier → Dr Interest on Delayed Payment, Cr Supplier (increases liability)
- Interest received from customer → Dr Customer, Cr Interest Received (increases their liability to us)
- Tally's interest calculation feature (F11 → Accounting Features) automatically tracks accruing interest on configured ledgers
- Simple interest is standard in B2B trade; compound interest applies to formal loans and is always higher over time
Quick Quiz
- Sunrise Retail owes ₹2,00,000 overdue to a supplier for 45 days at 18% p.a. Simple interest =
- a) ₹3,600
- b) ₹4,438
- c) ₹2,000
- d) ₹36,000
Show answer
b) ₹4,438 — ₹2,00,000 × 18 × 45 ÷ (100 × 365) = ₹16,20,000 ÷ 36,500 = ₹4,438 (rounded).
- When TechWorld charges interest on Sunrise Retail's overdue account, the entry in Sunrise Retail's books is:
- a) Dr Interest Received, Cr TechWorld
- b) Dr Interest on Delayed Payment, Cr TechWorld
- c) Dr TechWorld, Cr Interest on Delayed Payment
- d) Dr Bank, Cr Interest Expense
Show answer
b) Dr Interest on Delayed Payment, Cr TechWorld — the interest is an expense to Sunrise Retail, and TechWorld's liability increases by that amount.
- In Tally, interest calculation is enabled in:
- a) Gateway → Inventory Features
- b) F11 → Accounting Features → Activate Interest Calculation
- c) Gateway → Reports → Interest
- d) The Purchase Voucher itself
Show answer
b) F11 → Accounting Features → Activate Interest Calculation — once enabled, interest parameters can be set on any ledger master.
- Compound interest is higher than simple interest over the same period because:
- a) Compound rate is always higher than simple rate
- b) Compound interest includes tax on interest
- c) Compound interest charges interest on accumulated previous interest
- d) There is no difference — both produce the same result
Show answer
c) Compound interest charges interest on accumulated previous interest — each period's interest becomes part of the principal for the next period, causing exponential growth.
Next: Module 19 — Purchase and Sales Orders — How Sunrise Retail places orders before actual transactions: the Order → Delivery → Invoice flow in Tally, and how to track pending orders and unfulfilled commitments.