Loading the player...

What is 'Amortization'

Amortization is the paying off of debt with a fixed repayment schedule in regular installments over a period of time for example with a mortgage or a car loan. It also refers to the spreading out of capital expenses for intangible assets over a specific period of time (usually over the asset's useful life) for accounting and tax purposes.

BREAKING DOWN 'Amortization'

Amortization is similar to depreciation, which is used for tangible assets, and to depletion, which is used for natural resources. When businesses amortize expenses, it helps tie the cost of the asset with the revenues it generates. For example, if a company buys a ream of paper, it writes off the cost in the year of purchase and generally uses all the paper the same year. Conversely, with a large asset, the business reaps the rewards of the expense for years, so it writes off the expense incrementally over several years.

Amortization of Loans

On auto loan and home loan payments, at the beginning of the loan term, most of the monthly payment goes toward interest. With each subsequent payment, a greater percentage of the payment goes toward the loan's principal. For example, on a five-year $20,000 auto loan at 6% interest, the first payment of $386.66 allocates $286.66 to principal and $100 to interest. The last monthly payment allocates $384.73 to principal and $1.92 to interest.

Amortization of Intangible Assets

To illustrate the amortization of an intangible asset, imagine XYZ Biotech spends $30 million dollars on a patent with a useful life of 15 years. Theoretically, to account for the expense over a 15-year period, XYZ Biotech records $2 million each year as an amortization expense.

Advantages of Amortizing Business Capital Expenses

Amortizing capital expenses helps present a more accurate view of the company's financial health. To continue with the above example, if XYZ Biotech writes off the entire cost of the expense in the year of purchase, the large amount detracts from the company's revenue for that year, making it look as though the company earned less. In contrast, by spreading the expense out of several years, the ledger reflects the true cost of doing business. In addition, spreading the expense over several years can help to make tax liability more consistent.

Amortization and the Internal Revenue Service

The Internal Revenue Service (IRS) allows taxpayers to take a deduction for certain amortized expenses: geological and geophysical expenses incurred in oil and natural gas exploration, atmospheric pollution control facilities, bond premiums, research and development, lease acquisition, forestation and reforestation, and certain intangibles such as goodwill, patents, copyrights and trademarks. Amortization can be calculated easily using most modern financial calculators, spreadsheet software packages such as Microsoft Excel, or amortization charts and tables.

To deduct amortization costs, the IRS requires tax filers to complete Part VI of Form 4563. The IRS has schedules dictating which percentage of an asset's cost a business should amortize each year, and these schedules break intangible assets into categories with slightly different amortization rates.

RELATED TERMS
  1. Amortization Of Intangibles

    A tax term relating to the practice of deducting the cost of ...
  2. Amortized Bond

    A financial certificate that has been reduced in value for records ...
  3. Negative Amortization Limit

    A provision in certain loan contracts that limits the amount ...
  4. Fully Amortizing Payment

    A periodic loan payment, part of which is principal and part ...
  5. Amortization Schedule

    A complete schedule of periodic blended loan payments, showing ...
  6. Amortized Loan

    A loan with scheduled periodic payments of both principal and ...
Related Articles
  1. Investing

    Explaining Amortization In The Balance Sheet

    Amortization is important to account for intangible assets. Read to find out more about amortization.
  2. Investing

    Explaining Amortization In The Balance Sheet

    Amortization occurs when an asset’s value decreases over time, usually over its estimated useful life.
  3. Personal Finance

    Mortgage Amortization Strategies

    Should you get a 30-year mortgage? A 15-year one? Ways to decide which mortgage is the best fit.
  4. Personal Finance

    What is an Amortization Schedule?

    An amortization schedule is a table that shows the amounts of principal and interest that comprise each loan payment.
  5. Investing

    Premium Bonds: Problems And Opportunities

    Learn all about premium bonds and how you can make them work for you.
  6. Small Business

    Writing Off the Expenses of Starting Your Own Business

    Learn how to navigate the complicated rules for writing off the expenses of starting your own business. It could save you a lot of money.
  7. Managing Wealth

    How to Calculate Your Tangible Net Worth

    Your net worth can be calculated with a simple equation.
  8. Personal Finance

    Choose Your Monthly Mortgage Payments

    Exotic mortgages allow you to decide how much to pay. Find out how much they really cost.
  9. Investing

    Intangible Assets Provide Real Value To Stocks

    Intangible assets don't appear on balance sheets, but they're crucial to judging a company's value.
RELATED FAQS
  1. Where do traders place orders when they identify ascending triangles?

    Learn which businesses are required to depreciate or amortize capital expenses, or CAPEX, and which businesses are eligible ... Read Answer >>
  2. How does one amortize intangible assets?

    Understand what distinguishes intangible assets and how companies are required to amortize their value over time to recover ... Read Answer >>
  3. What are the differences between amortization and impairment?

    Learn the differences between amortization and impairment as they relate to intangible assets held on a company's balance ... Read Answer >>
  4. How should you choose the amortization period for your mortgage?

    Read about key considerations that homeowners should take into account before choosing the amortization period for their ... Read Answer >>
  5. What is the difference between amortization and depreciation?

    Because very few assets last forever, one of the main principles of accrual accounting requires that an asset's cost be proportionally ... Read Answer >>
  6. Are student loans amortized?

    Student loans typically get paid back over time on a fixed payment, or amortized, schedule. Read Answer >>
Hot Definitions
  1. Graduate Record Examination - GRE

    A standardized exam used to measure one's aptitude for abstract thinking in the areas of analytical writing, mathematics ...
  2. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
  3. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
  4. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  5. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  6. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
Trading Center