In finance, amortization refers to the process of paying off a debt over time by making scheduled, periodic payments of principle and interest. To amortize a debt is to “put it out of its misery.” In accounting, amortization is the process of charging or writing off the cost of an intangible asset as an operating expenditure over the course of the asset’s expected useful life in order to lower a company’s taxable profit.
What is Amortization?
The term “amortization” has two meanings. Payment of a loan over a certain length of time is referred to as the term. Also known as deferred maintenance, this word refers to the process of spreading capital expenditures made on intangible assets like as brand names, patents, copyrights, trademarks, goodwill, and other intangible assets over a particular time period. The cost is assigned for the purposes of taxation and accounting.
Explanation of the Term Amortization
When it comes to loan repayment, amortization refers to the ongoing payment of a debt in installments according to a predetermined repayment plan. The majority of the time, amortization is used to vehicle and home loans. Typically, interest is included in the monthly payment during the first few months of the repayment plan. With each consecutive payment, the share of the principal amount becomes more and larger.
A 30-year, $120,000 mortgage with a 5 percent interest rate, for example, would result in the first monthly payment of $663, of which $138 would be for the principle and the remaining $525 would be for interest payments on the principal. There would be one last payments of $2,651, of which $2,622 would be the main amount and $29 would be the interest payment.
When it comes to accounting for intangible assets, the term “amortization” has a completely different meaning than when it comes to actual assets. The notion of depreciation and depletion, which are applied to tangible assets and natural resources, respectively, is comparable to the concept of depreciation and depletion. It simply refers to the distribution of expenditures spent on an intangible asset in such a manner that the expenses incurred on the asset are equal to the revenues generated by the asset.
Consider the following scenario: ABC pharmaceutical business has invested $40 million on a medicine patent that will be valid for 14 years. The corporation will not record the whole sum in a single accounting quarter, as is customary. Instead, the sum will be divided out over a period of 15 years by the corporation. As a result, the business will incur amortization expenditures of $2.85 million in its financial statements. Amortization is the term used to describe the process of spreading the costs associated with a patent over a certain period of time.
In the United States, the Internal Revenue Service allows businesses to deduct costs spent on the following items as amortization expenses.
For example, research and development costs, lease acquisition costs, geologic and geophysical costs, forestation and reforestation costs, and intangible assets costs are included (copyrights, patents, goodwill, and trademarks).
It is possible to calculate amortization with the use of internet calculators, financial calculators, and spreadsheet tools such as Microsoft Excel.
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