Amortization

Meaning of Amortization

Process of Amortization

Why amortization is used

Difference b/w amortization & depreciation

Meaning of Amortization

Amortization means to pay off cost of any asset gradually. As an accounting term, it refers to the process of allocating the cost of an asset over a period of time.

Process of Amortization

This term is used for two separate processes-

  • Amortization of loans
  • Amortization of intangible assets

 Amortization of loans:

Amortization of loan is the process of repayment of a loan in instalments by the borrower. It is usually done in an agreed period and every instalment includes a part of the total loan plus the interest. To amortise a loan means to “kill it off”.

For ex. – Let’s assume Company ‘A’ has RS. 10 lakh loan outstanding. If Company ‘A’ repays RS. 1 lakh of that principal every year, we would say that RS. 1 lakh of the loan has amortized each year.

 Amortization of intangible assets:

The amortization of intangible assets refers to the process of distributing the cost of an intangible asset over agreed time.

For ex. Let’s assume company ‘A’ owns the patent on a piece of technology, and that patent lasts 15 years. If the company spent RS. 15 lakh to develop the technology, then it would record RS. 1 lakh each year for 15 years as amortization expense on its income statement.

*Intangible assets are the assets which are incapable of being perceived by the sense of touch, as immaterial things. These do not have physical presence but add value to one’s business. If an intangible asset has an indefinite lifespan, it cannot be amortized for ex. goodwill.

Examples of intangible things:

Why Amortization is important

To protect one’s business and operate under the law, a businessman might obtain licenses, trademarks, patents, and other intangible assets. These items can be costly to a small business. He can use amortization to reduce his taxable income throughout the life of intangible assets.

Difference between Amortization and Depreciation

Amortization is similar to depreciation, but the difference is that the depreciation is used only on tangible assets. Tangible assets are physical items like vehicles, buildings, equipments etc. 

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