Amortization

Amortization, abbreviated as A, is the process of spreading out the cost of an intangible asset or the repayment of a loan over a specific period.  It involves systematically reducing the value of an asset or the balance of a loan through periodic payments.

There are two primary contexts in which amortization is commonly used

• Intangible Assets  -  In accounting, amortization is the process of allocating the cost of intangible assets, such as patents, copyrights, trademarks, and goodwill, over their useful life.  Intangible assets are not physical in nature but provide future economic benefits to the entity.  Instead of being expensed immediately, the cost of these assets is gradually expensed over time as they are utilized to generate revenue.
• Loan Repayment  -  In the context of loans, such as mortgages or car loans, amortization refers to the systematic repayment of the principal amount of the loan along with the interest charges over the loan term.  Each periodic payment made by the borrower typically consists of both principal and interest components.  Initially, a larger portion of the payment goes toward paying off the interest, while a smaller portion is applied to reduce the principal balance.  Over time, as the principal balance decreases, the portion of the payment applied to interest decreases while the portion applied to principal increases.

The amortization process ensures that the cost of an asset or the balance of a loan is appropriately accounted for over its useful life or repayment period.  It helps in accurately reflecting the consumption of benefits or the reduction of liabilities over time in financial statements and reports.

In summary, amortization is the gradual reduction of the value of an asset or the repayment of a loan through periodic payments, and it is a fundamental concept in both accounting and finance.

 

Amortization Formula

\( A =  P \;  [\;i \; \left( 1 + i   \right)^{  n }  \;/\; \left( 1 + i  \right)^{ n } - 1 \;]   \)

Symbol

\( A \) = amortization

\( P \) = principle

\( i \) = interest rate

\( n \) = total number of payments