What is Amortization?
Amortization is the process of repaying a debt in predetermined, periodic payments that include both principal and interest. Payments are made in the form of principal and interest specifically in every area where the term amortization is used.
The amortization of a loan is the process of paying back pending balance in full, over time. When a loan is issued, a set of fixed payments is usually arranged at the outset, and the person who gets the loan is responsible for making each payment. The loan’s principal and interest payments will change from month to month, but the payment amount will remain consistent each payment cycle.
When it comes to assets that aren’t physical, such as branding, intellectual property, and trademarks, the term “amortization” has a different meaning. Amortization, like depreciation of fixed assets, is the periodic drop in value over time in this context. It refers to the periodic reduction of the book value over a specified period of time, regardless of whether you’re talking about a loan or an intangible asset. The process of amortization is made simpler by having a great accountant or loan officer who understands the specific needs of the organization or individual for whom he or she works.
Amortization can also refer to the amortization of intangibles. In this case, amortization is the process of expensing the cost of an intangible asset over the estimated life of the asset. It measures the consumption of the value of an intangible asset, such as goodwill, a patent, a trademark, or copyright.
What Is The Relation Between Amortization And Depreciation?
Similar to the notion of depreciation, Amortization usually refers to debt or loans, but it can also refer to the habit of regularly lowering the value of intangible assets. Amortization and depreciation are similar concepts, in capturing the cost of holding an asset over time. The main difference between them, however, is that amortization refers to intangible assets, whereas depreciation refers to tangible assets. Examples of intangible assets include trademarks and patents; tangible assets include equipment, buildings, vehicles, and other assets subject to physical wear and tear.
Amortization is calculated in a similar manner to depreciation—which is used for tangible assets, such as equipment, buildings, vehicles, and other assets subject to physical wear and tear—and depletion, which is used for natural resources. When businesses amortize expenses over time, they help tie the cost of using an asset to the revenues that it generates in the same accounting period, in accordance with generally accepted accounting principles (GAAP). For example, a company benefits from the use of a long-term asset over a number of years. Thus, it writes off the expense incrementally over the useful life of that asset.
Why Is Amortization Significant?
Amortization is significant because it helps businesses and investors understand and foretell their costs over time. In the context of loan repayment, amortization schedules provide clarity into what portion of a loan payment consists of interest versus principal. This can be helpful in deducting interest payments for tax purposes.