What is ‘Amortization’
Amortization is the paying off of debt with a fixed repayment schedule in regular installments over a period of time. Consumers are most likely to encounter amortization with a mortgage or car loan.
2. 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. Amortization is similar to depreciation, which is used for tangible assets, and to depletion, which is used with natural resources. Amortization roughly matches an asset’s expense with the revenue it generates.
BREAKING DOWN ‘Amortization’
1. With 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 principal. For example, on a 5-year, $20,000 auto loan at 6% interest, the first monthly payment of $386.66 would be allocated as $286.66 to principal and $100 to interest. The last monthly payment would be allocated as $384.73 to principal and $1.92 to interest. At the end of the loan term, all principal and all interest will be repaid.
2. Suppose XYZ Biotech spent $30 million dollars on a patent with a useful life of 15 years. XYZ Biotech would record $2 million each year as an amortization expense.
The IRS allows taxpayers to take a deduction for the following 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.
March 5, 2016