What Exactly is Amortization?

by Investing School on December 17, 2009

Amortization has different meanings depending on whether you are in business or accounting. In business, amortization is when a lump-sum cash flow is distributed into smaller cash flow amounts for the purpose of installments. The installment payments are determined by the amortization schedule. This installment schedule of payments is different from other repayment plans because it consists of both principal and interest.

Amortization is used mainly in loan repayments. This is found typically in mortgage loans. It is also found in sinking funds. Sinking funds are funds that are established by a business or a government agency in order to help consumers reduce debt. The payments are divided equally for the duration of the loan which makes it a simple repayment system. The beginning of the model shows a heavier payment of interest on the beginning of the amortization schedule. Then more money is applied to the principal at the end of the amortization schedule.

In accounting, amortization means expensing the acquisition cost and subtracting the residual value of intangible assets in an analytical way that takes into consideration their consumption, expiration or any other decline over a period of time. This is most often referring to intellectual property.

Amortization is detailed in financial statements as a reduction in the carrying value of a particular intangible asset on the balance sheet and will then be added as an expense on the income sheet.

If you are looking for guidance for accounting of amortization, it can be found in the International Accounting Standard 38, Intangible Assets.

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