Amortization is an accounting term that helps lower the initial or book value of an intangible asset or borrowed sum over a period of time. You can utilize an amortization schedule to reduce your balance left on the loan, like paying installments or EMI on a car loan. Amortization is also the practice of spreading the capital expenses in relation to the intangible assets over a set duration of time, in the asset’s life, for the use of accounting and taxes.
What is Amortization?
Amortization is an accounting term that helps lower the initial or book value of an intangible asset or borrowed sum over a period of time. This means the loan payments will scatter over time, and in an asset depreciation and amortization are similar.
How does amortization work?
Amortization can be interpreted in 2 ways. In the first instance, it means paying off your debt with continued payments on the principal for a set term. You can utilize an amortization schedule to reduce your balance left on the loan, like paying installments or EMI on a car loan.
The second instance is the practice of spreading the capital expenses in relation to the intangible assets over a set duration of time, in the asset’s life, for the use of accounting and taxes.
Loans
Amortization simply means paying back your loan in small installments rather than the lump sum. This can be through regular or monthly payments that relax the payee and is able to pay the loan before the time of maturity. A high percentage in monthly installments pays the interest, while some other percentage of it goes towards the payment of the principal amount.
You can calculate amortization through spreadsheets, calculators, software, etc. The schedule starts with the loan balance that is impending. This is then divided by the number of months. The amount of principal outstanding is calculated by subtracting the interest from the same.
This is a handy tool for accountants who want to spread the costs over time of the lifetime of an asset.
Interpretation in intangible assets
This is in the case of intangible assets. This means expanding the cost of any asset over the lifetime of that asset. This usually measures the patent, goodwill, trademark, or copyright.
Amortization and depreciation are not far away in their calculation or impact. The difference being the latter is for tangible assets mostly. When amortization is for intangible assets, it helps determine the usage of an asset according to GAAP. GAAP stands for Generally Accepted Accounting Principles.
This also helps in tax payment and planning. IRS (Internal Revenue Service) renders the ability to taxpayers to deduct expenses by predetermination. These include geophysical expenses, geological expenses, due to natural gas exploration, atmospheric pollution, bond premiums, R&D (Research & Development), patents, goodwill, reforestation, copyrights, trademarks, etc.
The IRS has defined the number of years for you to expand the cost of these tangible or intangible assets.
Importance of amortization
It aids organizations in understanding and determining the costs of assets. It also reduces the value of the same over time. The amortization schedule brings more clarifications to loan repayment. Hence, it helps define what portion is the interest and what is the principal. Hence, it gives you a clear idea as to how much principal balance to pay.
Amortization of intangible assets helps to cut down the taxable income and the tax liability. It also helps to determine the true extent of the earnings in a business.
