AICPA CPA-Business Exam - Topic 1 Question 125 Discussion

Choice 'c' is correct. This question is a compound interest question because the interest is to be determined at the end of the second year. The calculation is as follows and uses different symbols than the SI = PIN formula in the text to show candidates the PRT formula as well (the CPA exam often uses different terminology):

Interest = PRT (for the first year)

Interest = $1,000 x .08 x 1 = $800 and adding the $800 to the beginning principal

Interest = PRT (for the second year)

Interest = $1,800 x .08 x 1 = $864

It is obvious from the answer that the interest earned in year 2 is interest earned on the original principal ($10,000 x .08 = $800) plus interest on the year 1 interest ($800 x .08 = $64).

Choice 'a' is incorrect. This answer is interest only on the original principal, and not on the year 1 interest.

Choice 'b' is incorrect. This answer has a decimal point error in calculating the year 2 interest on year 1 interest.

Choice 'd' is incorrect. This answer is apparently made up. It is sometimes difficult to come up with 3 decent wrong answers, especially with simple questions.