Amortized cost definition
/What is Amortized Cost?
The amortized cost concept can be applied to several scenarios in the areas of accounting and finance, which are noted below.
Amortized Cost of Fixed Assets
Amortized cost is that accumulated portion of the recorded cost of a fixed asset that has been charged to expense through either depreciation or amortization. Depreciation is used to ratably reduce the cost of a tangible fixed asset, and amortization is used to ratably reduce the cost of an intangible fixed asset. The amortized cost term can also be applied to the accumulated amount of depletion of a natural resource that has been charged to expense.
For example, ABC International has been depreciating a machine in its production area for the last five years. The $48,000 that has been charged to depreciation expense thus far is its amortized cost.
As another example, ABC has been amortizing the acquired cost of a patent for several years. The $75,000 that has been charged to expense thus far over the life of the intangible asset is its amortized cost.
As another example, ABC has been depleting the recorded cost of a coal mine for the past ten years. The $1.2 million that has been charged to depletion thus far is its amortized cost.
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Amortized Cost of Securities
It is the cost of a security, plus or minus adjustments for any purchase discounts or premiums associated with the purchase of the security. A purchase discount arises when an investor pays less than the face value of a security in order to increase the effective interest rate, while a purchase premium is paid when the interest rate paid on a security is higher than the market interest rate.
FAQs
What is the difference between amortized cost and market value?
Amortized cost measures a financial asset at its original cost adjusted for principal repayments, amortization of premiums or discounts, and impairment. Market value reflects the current price at which the asset could be sold in an orderly transaction. Amortized cost emphasizes contractual cash flows, while market value captures fair value volatility.
What is the impact of amortization on amortized cost?
A more rapid rate of amortization, depreciation, or depletion will result in a higher amortized cost during the first few years of an asset’s useful life. For example, 40% of the total cost is amortized in the first year under the double declining balance method when the amortization period is five years. When amortization occurs at such a rapid rate, it is less likely for the underlying asset to be impaired (since its net book value is more likely to be lower than its market price).