Amortization definition
/What is Amortization in Accounting?
Amortization is the process of incrementally charging the cost of an asset to expense over its expected period of use. Doing so incrementally shifts the recorded amount of an asset from the balance sheet to the income statement of a reporting entity. It essentially reflects the consumption of an intangible asset over its useful life. Amortization is most commonly used for the gradual write-down of the cost of those intangible assets that have a specific useful life. Examples of intangible assets are patents, copyrights, taxi licenses, and trademarks. The concept also applies to such items as the discount on notes receivable and deferred charges.
Amortization in Lending
The amortization concept is also used in lending, where an amortization schedule itemizes the beginning balance of a loan, less the interest and principal due for payment in each period, and the ending loan balance. The amortization schedule shows that a larger proportion of loan payments go toward paying off interest early in the term of the loan, with this proportion declining over time as more and more of the loan's principal balance is paid off. This schedule is quite useful for properly recording the interest and principal components of a loan payment. The schedule also clarifies how long it takes to pay off the principal on a loan, since only a small portion of the earlier payments on a loan are used for this purpose; most of each payment is used to pay off interest expense.
Accounting for Amortization
The journal entry to record amortization for an intangible asset is:
If an intangible asset has an unlimited life, then it is still subject to a periodic impairment test, which may result in a reduction of its book value.
For example, ABC International has spent $100,000 to acquire a broadcast license that will expire and be put up for auction in five years. This is an intangible asset, and should be amortized over the five years prior to its expiration date. The entry in each year would be:
FAQs
How does amortization differ from depreciation?
Amortization allocates the cost of an intangible asset, such as a patent, copyright, or customer list, over its useful life. Depreciation allocates the cost of a tangible fixed asset, such as equipment or vehicles. Both reduce book value and expense cost over time, but apply to different asset types.
Can tax amortization differ from book amortization?
Yes. Tax amortization can differ from book amortization because tax law may prescribe different recovery periods, methods, or eligibility rules than financial reporting standards. For example, an intangible may be amortized over 15 years for tax purposes while using a shorter useful life for book reporting, creating temporary tax differences.