In business, amortization
refers to spreading payments over multiple periods. The term is used for two separate processes: amortization of loans and amortization of assets. In the latter case it refers to allocating the cost of an intangible asset
over a period of time (for example, over the course of a 20-year patent term, $1,000 would be recorded each year as an amortization expense if $20,000 was initially spent developing a product
Amortization of loans
In lending, amortization is the distribution of loan repayments into multiple cash flow installments, as determined by an amortization schedule
. Unlike other repayment models, each repayment installment consists of both principal
, and sometimes fees if they are not paid at origination or closing. Amortization is chiefly used in loan
repayments (a common example being a mortgage loan
) and in sinking funds
. Payments are divided into equal amounts for the duration of the loan, making it the simplest repayment model. A greater amount of the payment is applied to interest at the beginning of the amortization schedule, while more money is applied to principal at the end. Commonly it is known as EMI or Equated Monthly Installment
where: P is the principal amount borrowed, A is the periodic amortization payment, r is the periodic interest rate divided by 100 (nominal annual interest rate also divided by 12 in case of monthly installments), and n is the total number of payments (for a 30-year loan with monthly payments n = 30 × 12 = 360).
(also called deferred interest) occurs if the payments made do not cover the interest due. The remaining interest owed is added to the outstanding loan balance, making it larger than the original loan amount.
If the repayment model for a loan is "fully amortized", then the last payment (which, if the schedule was calculated correctly, should be equal to all others) pays off all remaining principal and interest on the loan. If the repayment model on a loan is not fully amortized, then the last payment due may be a large balloon payment
of all remaining principal and interest. If the borrower lacks the funds or assets to immediately make that payment, or adequate credit to refinance the balance into a new loan, the borrower may end up in default
Amortization of intangible assets
, amortization refers to expensing the acquisition cost minus the residual value of intangible assets
in a systematic manner over their estimated "useful economic lives" so as to reflect their consumption, expiry, and obsolescence, or other decline in value as a result of use or the passage of time.
is a corresponding concept for tangible assets. Methodologies for allocating amortization to each accounting period are generally the same as these for depreciation. However, many intangible assets such as goodwill
or certain brands
may be deemed to have an indefinite useful life and are therefore not subject to amortization (although goodwill is subjected to an impairment test every year).
While theoretically amortization is used to account for the decreasing value of an intangible asset
over its useful life, in practice many companies will amortize what would otherwise be one-time expenses through listing them as a capital expense
on the cash flow statement
and paying off the cost through amortization, having the effect of improving the company's net income
in the fiscal year or quarter of the expense.
- ^ "What Is Amortization? Definition and Examples". Retrieved 2021-06-26.
- ^ "~What is an EMI ? ~ Equated Monthly Installment". Tech-bie.blogspot.com. 2011-07-15. Archived from the original on 2012-03-25. Retrieved 2012-11-23.
- ^ Wikinvest's Coverage of Amortization
- ^ "International Accounting Standard 38, Intangible Assets" (PDF). Iasb.org. Archived from the original (PDF) on 2012-02-15. Retrieved 2012-11-23.
- ^ "Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets"(PDF). Fasb.org. Retrieved 2012-11-23.
Last edited on 26 June 2021, at 16:59
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