Accounting for the effective interest rate is a crucial accounting technique to determine the true cost of borrowing or lending money. It factors in the effect of compounding interest over the loan period, providing a more accurate representation of the interest rate compared to the nominal or stated rate.
Effective interest rate is highly relevant in financial analysis and decision-making. It enables businesses to compare different financing options and make informed choices. It also helps investors assess the true cost of bonds and other fixed-income securities. A key historical development was the adoption of the International Financial Reporting Standard (IFRS) 9 in 2018, which standardized the accounting for effective interest rate across jurisdictions.