Daily Interest Charges, Accounts Receivable, Credit Cards, Banks, Income Tax.
September 13th, 1997, Last updated 14 July 2007
This topic is included because someone may have a USA program for their Accounts Receivable and it may add daily interest. 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.
These are old examples, but they illustrate the point.
American Express (Latest?) Finance Charges for most cardholders are effective on the first closing date after June 11th 2006.
Agreement states "LATE CHARGES (INTEREST) ON PURCHASES AND CASH ADVANCES: 2.5% per month, corresponding to an annual rate of 30.00%. It is not clear from the Agreement if Diners Club is using a daily rate or not. In any event 2.5% per month is 34.49% effective annual rate. A daily rate has the effect of increasing the interest charged and at 2.5% per month, adding interest daily is adding insult to injury!
CIBC Aerogold monthly statements declare that the daily interest rate is 0.04794% and that the annual interest rate is 17.50%. The daily interest charge is stated as 17.50% divided by 365 to get 0.0479452 rounded to 0.04794. One need only look at
Interest on Accounts Receivable to see that VISA is charging more than 17.50% effective annual interest. Using the USA methods we can say (estimate, it should be lower) that the monthly rate is 17.50% divided by 12 or 1.45833. each month, and that is closer to 19% (18.97%) than 17.50%, but even that is wrong. The monthly rate for 17.50% is 1.3529722, and estimating the corresponding daily rate by 1.353 times 12 divided by 365 we get 0.04448, so VISA is charging more that the annual rate it says it is as required by the Interest Act
Diners Club EnRoute Maple Leaf Club Cardholder Agreement states "LATE CHARGES (INTEREST) ON PURCHASES AND CASH ADVANCES: 2.5% per month, corresponding to an annual rate of 30.00%. It is not clear from the Agreement if Diners Club is using a daily rate or not. In any event 2.5% per month is 34.49% effective annual rate. A daily rate has the effect of increasing the interest charged.
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 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!
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 the CIBC yearly rate of 17.50% as required by the Interest Act, that the CIBC shows on its Visa statement and NOT the daily interest rate shown as 0.04794% (17.50/365 = 0.4794521), that they also use, 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 1.3529721718319232, say 1.352972, and the daily rate should be 1.352972 * 12/365 or 0.04448172 per day. We will use $100.00 as the charges at 11:00pm that Saturday. The Effective Interest that full day is $100 * 0.04448172 or $4.448172.
We only have the use of the money for one hour on that Saturday. So we paid $4.448172 for that use. That is an effective rate of $4.448172 * 24 hours or 106.7561 per day. It does not take a genius to determine that this rate is more than 60% 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 that day 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?
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.
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