To the Index, Daily Interest Charges, Accounts Receivable, Credit Cards, Banks, Income Tax.

September 13th, 1997, Last updated May 24th, 2009.

This topic is included because someone may have a USA program for their Accounts Receivable and it may add daily interest to overdue accounts. If so, you may not be following the requirements of the Interest Act and this will tell you why. Fix it!
The basis for charging interest in Canada is the Interest Act that requires an express statement of the yearly rate or percentage of interest to which such other rate or percentage [day, week, month, or at any rate or percentage for any period less than a year] is equivalent.
The Monthly schedule of mortgage payments calculates monthly mortgage payments for interest payments calculated yearly or half-yearly, not in advance as required by the Interest Act. The difference between yearly or half-yearly calculations is that at the half year a rest is made and the interest accrued to then is added to the principal, thus compounding and slightly increasing the amount the borrower or customer has to pay. So the interest is calculated each month but is not added to the principal until the half year.

Accounts receivable are usually sent on a monthly basis and interest is added some time after the account is sent. Once the interest is added to the account it is compounded on future delinquent accounts until paid. Or to put it another way a rest is made each month and the interest is compounded monthly, so the daily interest is accumulated on the daily balance and added at the end of the pay period.

What follows is of limited interest!

Perhaps the easiest way to show how your computer should be programmed to charge daily interest is to show how some of the USA programs, and Canadians using USA programs, do it in contravention of the Interest Act.

Here are some examples that illustrate the point.

American Express Business Finance Charges January 2009 Statement shows annual interest rate of 25.99%, and a daily periodic rate of 0.0712%.
The daily rate is calculated by dividing the annual rate of 25.99% by 365 days to get 0.0712%.
One need only look at Interest on Accounts Receivable to see that American Express is charging more than 25.99% effective annual interest.

We know that AMEX is charging 0.0712% per day. How much is that a month. It is 0.0712% times 365 divided by 12 or 25.99% divided by twelve or 2.166% effective interest per month. That is 29.32%, but even that is wrong. See discussion below.

American Express is charging more that the annual rate it says it is as required by the Interest Act

All of these are incorrect by being understated:
CIBC Aerogold (2009) monthly statements declare that the yearly interest rate is 19.50% and that the daily interest rate is 0.05342%yearly
CIBC Visa Platinum (2009) monthly statements declare that the yearly interest rate is 18.50% and that the daily interest rate is 0.05068%;
Mosaic Mastercard (2009) monthly statements declare that the yearly interest rate is 18.50% and that the daily interest rate is 0.05068%;
RBC Visa Business (2009) monthly statements declare that the yearly interest rate is 19.50% and that the daily interest rate is 0.05342%;
RBC Visa Platinum (2009) monthly statements declare that the yearly interest rate is 24.50% and that the daily interest rate is 0.06712%;
MBNA Visa (2009) monthly statements declare that the yearly interest rate is 27.98% and that the daily interest rate is 0.076658%;
Capital One (2009) monthly statements declare that the yearly interest rate is 18.80% and that the daily interest rate is 1.56667%.

Choice Rewards MasterCard (2009) monthly statements declare that the yearly interest rate is 19.99% BUT the daily interest rate is not stated.

But some get it right!
Aliant - 1.25% Per Month, 16.08% per year
Bell ExpressVU - 2% Per Month, 26.82% per year
Irving - 2% Per Month, 26.82% per year

The point of all this is that for businesses in Lunenburg County, or perhaps for small businesses all over Canada, you should check to see if your accounts receivable program is calculating the interest charges correctly according to the Annual Effective Rate shown on your invoices and statements. For a small business with few accounts receivable is is probably better to charge a slightly higher annual rate than to be bothered with daily interest.

It is only the Banks, Credit Cards, and large retail companies, and the Income Tax arrears and penalties, where the pennies, nickels, and dimes really add up to a big or significant number that daily interest makes sense. If you must use daily interest you must start from the effective annual rate, use the calculations from Interest on Accounts Receivable or do your own calculation from that program. If you are charging daily interest you should use the MONTHLY interest rate times 12 divided by 365 to get an average daily rate. Then you have to check to make sure that the daily rate is NOT applied to part of a day (that increases the effective rate) and is NOT applied both before the rest and after the rest on the same day. If you really want to be accurate, perhaps the addition of interest should take place at midnight on the day it is added. GOOD LUCK!

DAILY INTEREST RATES

So lets start our analysis of daily interest rates. How they must be calculated? How far off are the disclosed rates? The first and last day you may be charged interest using a daily rate without it being a Criminal Offense under the Criminal Code. You borrow money, have dinner, or purchase something (you did not pay your account in full last month!) at 11 p.m. on a Saturday. What happens if interest is added including this day, a Saturday, as an interest bearing day.

We will use a yearly rate of 17.50% as required by the Interest Act, and NOT the daily interest rate shown on most cards, but is clearly wrong.

What are the effective rates required by the Interest Act? The monthly rate required by Convert Yearly rate to monthly rate is 1.352972%, and the daily rate should be 1.352972% * 12/365 or 0.0444817% per day. We will use $100.00 as the charges at 11:00pm that Saturday. The Effective Interest that full day is $100 * 0.0444817/100 (Divide by 100 to convert per cent to per unit or 0.0444817/100 equals $0.000444817pu).

We only have the use of the money for one hour on that Saturday. So we paid $0.04448172 for that use. That is an effective rate of $0.04448172% * 24 hours or $1.06756 per day ($33 per month). It does not take a genius to determine that this rate is more than 60% per year and is a Criminal offense under the Criminal Code. The computer programs must be designed to charge interest on the balance carried forward to that Saturday, but the interest on purchases or money advances made on that Saturday must not be added until the following day. The same reasoning applies to the day of rest or billing date. Interest on charges made on the billing date must be added on the following day.

Saturday was used in this demonstration because the banks are usually closed on Saturday and are closed on Sunday. If you get cash from an ATM it is clear that you have the use of the money from the time you get it. But when does the merchant get his money? So when should the Credit Card company charge you for the interest?

The same argument applies to the day of a payment and the result is that both the charge and the payment days should be excluded from the Credit Card calculation of interest payable. We do not know the formula for calculating Credit Card interest and without that we can only assume that interest is charged on both the charge and the payment day.

But that is not all. There are rounding errors which may be programmed in favour of a Bank and in favour of a Credit Card or any other interest charging businesses. These rounding errors occur because when calculating interest the result is usually calculated using as many decimal places as the computer is programmed to use. The calculated interest is saved in the computer memory using the maximum number of decimal places. Using a rounding function does not charge the already stored memory to only two decimal places. The rounded interest must be saved to a different memory to preserve the new rounded number.



How interest is charged on arrears of Income Tax and penalties is a mystery, but the Canada Revenue Agency, CRA, Information Bulletin it421r2-e.pdf indicates that interest is applied as follows:

EXAMPLE
3. The following example illustrates the calculation of a benefit under subsection 80.4(1) in 1990 for an employee on a $100,000 loan from his or her employer. The prescribed rate is 13% for the first two quarters in the year and 14% for the last two quarters. Assume that within the year or 30 days thereafter $5,000 of interest was paid on the loan by the employee and that a company related to the employer paid $3,000 of interest on the loan on behalf of the employee in that period. Also, within the year the employee repaid $2,000 to the company that paid the $3,000.
(a) Prescribed rate multiplied by the loan amount for the period in the year
(i) 13% X $100,000 X 2/4 = 6,500
(ii) 14% X $100,000 X 2/4 = 7,000
-----
$13,500
PLUS
(b) Amounts paid by related company 3,000
-------
Subtotal $16,500
Less
(c) Amounts of interest paid
($5,000 + $3,000) [total paid] 8,000
(d) Amount repaid by employee 2,000 [making the total paid] 10,000
----- -------
Benefit to Employee [subtotal less total paid] $ 6,500
| ----- -------
I guess the CRA is not required to follow the Interest Act because the effective interest rate is higher than the stated rates. And interest payments all seem to be applied at the end of the year.

Do we suppose that Parliament really meant this when it specified an interest rate?

NOTES:

Terracan Corporation v. Pine Projects Ltd(1993), 100 D.L.R. (4th) 431 (B.C.C.A.), affirming (1991), 60 B.C.L.R. (2d) 384 (S.C.), held that an effective annual rate of interest must be calculated by compounding annually.
In February 1992 the Canadian Institute of Actuaries stated that annual compounding is the only way to calculate an effective annual rate of interest in accordance with generally accepted actuarial practices and principles.