The amortized cost concept can be applied to several scenarios in the areas of accounting and finance, which are as follows:
- 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.
- 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 rate.
Amortized cost does not necessarily have any relationship between the adjusted cost of an asset and its market value. Market value could potentially be much higher or lower than the original cost of an asset net of its amortized cost.
A more rapid rate of amortization, depreciation, or depletion will result in a higher amortized cost, which means that 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).