What is an Amortization Expense? Definition Meaning Example

Amortization Accounting Definition

In general, the word amortization means to systematically reduce a balance over time. In accounting, amortization is conceptually similar to the depreciation of a plant asset or the depletion of a natural resource. Patriot’s online accounting software is easy-to-use and made for small business owners and their accountants. For example, a company often must often treat depreciation and amortization as non-cash transactions when preparing their statement of cash flow.

What is difference between amortization and depreciation?

Amortization is the method that is used to decrease the cost of the asset over time, while depreciation is the loss in value of the asset over time. This understanding helps in better understanding the financial implications of the purchase and saving time, effort, and money.

A method of progressively lowering an account balance over time is called amortization. A steadily increasing part of the debt payment is applied to the principal each month while loans are amortized. Like depreciation, How to Figure Out Total Liability & Stockholders’ Equity Chron com amortization of intangible assets involves taking a specified percentage of the asset’s book value off each month. This method is used to demonstrate how a corporation benefits from an asset over time.

What Does Amortization Expense Mean?

However, the process for determining useful lives and selecting allocation methods is more difficult compared to the case of depreciation. These articles and related content is the property of The Sage Group plc or its contractors or its licensors (“Sage”). Please do not copy, reproduce, modify, distribute or disburse without express consent from Sage. These articles and related content is provided as a general guidance for informational purposes only.

  • Under International Financial Reporting Standards, guidance on accounting for the amortization of intangible assets is contained in IAS 38.
  • It also has a unique set of rules for tax purposes and can significantly impact a company’s tax liability.
  • As the outstanding loan balance decreases over time, less interest should be charged each period.
  • Since your payment should theoretically remain the same each month, more of your payment each month will apply to principal, thereby paying down the amount you borrowed over time.

Typically, more money is applied to interest at the start of the schedule. Towards the end of the schedule, on the other hand, more money is applied to the principal. (Cost of asset-salvage value)/Number of years the asset can add value. News of the sale caused two other inventors to challenge the application of the patent.

Getting To Know the Amortization Process

The process of value reduction for a debt or an intangible asset is known as amortization. Many examples of amortization in business relate to intellectual property, such as patents and copyrights. When an asset brings in money for more than one year, you want to write off the cost over a longer time period. Use amortization to match an asset’s expense to the amount of revenue it generates each year. If an intangible asset has an unlimited life, then it is still subject to a periodic impairment test, which may result in a reduction of its book value.

What is amortization in accounting?

Amortization is an accounting method for spreading out the costs for the use of a long-term asset over the expected period the long-term asset will provide value. Amortization expenses account for the cost of long-term assets (like computers and vehicles) over the lifetime of their use.

Essentially, it’s a way to help determine the reduced value of an asset. This can be to any number of things, such as overall use, wear and tear, or if it has become obsolete. Every year the business records a decrease in the patent’s value, it must also record a corresponding amortization expense equal to the decrease. The business will record an amortization expense to reflect the decrease in the asset’s value. These items are amortized on a straight-line basis over their economic or legal life, whichever is shorter.

Depreciation vs. Amortization Comparative Table

To get this clear understanding of the way your bank collects dues, amortization helps a lot. Amortization, in general, is writing off a part of its value every year. Just like how a balloon deflates over time, your assets lose some of their worth too. Either way, their value holds a financial significance and must not be ignored.

ABZ successfully defended the patent but incurred legal fees of $50,000. The customary method for amortization is the straight-line method. Brainyard delivers data-driven insights and expert advice to help businesses discover, interpret and act on emerging opportunities and trends. Harold Averkamp has worked as a university accounting instructor, accountant, and consultant for more than 25 years.

Accounting Basics

If an intangible asset has an indefinite lifespan, it cannot be amortized (e.g., goodwill). Depreciation of some fixed assets can be done on an accelerated basis, meaning that a larger portion of the asset’s value is expensed in the early years of the asset’s life. Depreciation is the expensing of a fixed asset over its useful life. Some examples of fixed or tangible assets that are commonly depreciated include buildings, equipment, office furniture, vehicles, and machinery.

Amortization Accounting Definition

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