The ledger titles which embrace this subject, are Interest, Discount and Premium. These are all often, and indeed generally, embodied in one account, headed Interest, yet they are radically different divisions of the account, both in their nature and manner of computation; although all tending to one point, when placed upon the merchant’s books, viz: to add to his total gains or losses.
McCullock’s Commercial Dictionary has the following definitions of Interest and Discount:
“Interest, is the sum paid by the borrower of a sum of money, or of any sort of valuable produce, to the lender, for its use.”
“Discount, is an allowance made on account of an immediate advance of a sum of money, not due till some future period.”
Premium, according to Webster’s Dictionary, is “a bounty, or something offered or given for the loan of money, usually a sum beyond the interest.”
These definitions, though not full, will yet serve as a foundation on which to construct an explanation that may make these terms more easy of comprehension. You perceive that in order to apply the definition of Interest, which I have quoted, we must look upon every person who is indebted to another, as a borrower; that is, as having in his possession, certain property which belongs of right to that other person; and for retaining the use of which he must pay him an equivalent. If you consider in this light all transactions in which Interest is demanded and paid, this portion of the subject will perhaps be sufficiently plain without additional comment.
It is in relation to the second division of the account that most confusion usually arises. There are not less than three distinct transactions, which are all included in the usual language of business men, under the single term Discount. They are:
1st. When a deduction is made for payment of a note or account before due; 2d. When a per centage is taken off from a sale, in consideration of ready money; 3d. When money is remitted from one country to another, at an additional expense or at a loss.
If at an expense, it is sometimes called Premium.
For illustration, under the 1st division; suppose A holds a note against B for $500 due in four months, and B comes to-day and proffers payment; the custom is, for A to deduct the interest on $500 for four months, from the face of the note; and to accept the balance as payment in full: thus considering the use of the remainder of the amount, sufficient to compensate for the deficiency in the payment of the face of the bill. But this is manifestly incorrect, if we take the existing law of this State, which declares the value of the money to be but six per cent. per annum, to be founded on just principles. For the interest on the remainder of the note, after deducting the interest on the face of the note therefrom, is not sufficient at the same rate per cent. to make up the original sum. So that B, by paying thus in advance, secures a larger rate of interest than is lawful. Yet this is the usage, and it is an old adage, and well established, that usage makes law. This is what is termed Bank Discount. True Discount, is such a sum, as, when deducted from the original debt, the interest on the balance will just equal the amount deducted. The method of ascertaining this is by proportion, or, as it is called in arithmetics, rule of three. Thus we would say, as the amount of $100. and interest for the given time and rate is to the interest on $100. for the same time and rate, so is the total sum to the amount of discount to be deducted therefrom. Stated thus,— 102.00 : 2.00 :: 500.00 : the answer.