What Is Amortization In Accounting?

Amortization involves the systematic reduction of an account balance, such as prepaid expenses or capitalized loan costs, over a specified time. Simply stated, amortization is the process ofreducing an amount. In accounting, amortization tables are used as support for journal entries and reconciliations that involve amortization expense. However, metrics such as EBITDA–earnings before what are retained earnings interest, taxes, depreciation and amortization–exclude amortization to get a true sense of operational profitability. Amortization of intangible assets differs from the amortization of a mortgage. The cost of intangible assets is divided equally over the asset’s lifespan and amortized to a company’s expense account. Amortization spreads an intangible asset’s cost over its useful life.

  • ) is paying off an amount owed over time by making planned, incremental payments of principal and interest.
  • In accounting, amortisation refers to charging or writing off an intangible asset’s cost as an operational expense over its estimated useful life to reduce a company’s taxable income.
  • On the other hand, the accumulated amortization results in a decrease in the value of the intangible asset in the Balance Sheet.

The key difference between amortization and depreciation is that amortization is used for intangible assets, while depreciation is used for tangible assets. Finally, because they are intangible, amortized assets do not have a salvage value, which is the estimated resale value of an asset at the end of its useful life. An asset’s salvage value must be subtracted from its cost to determine the amount in which it can be depreciated. Let’s say a company spends $50,000 to obtain normal balance a license, and the license in question will expire in 10 years. Since the license is an intangible asset, it should be amortized for the 10-year period leading up to its expiration date. Amortization is a method of spreading the cost of an intangible asset over a specific period of time, which is usually the course of its useful life. Intangible assets are non-physical assets that are nonetheless essential to a company, such as patents, trademarks, and copyrights.

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For example, the cost of intangible assets (e.g. licenses, patents, trademarks, copyrights) will be expensed each period equally. If Company ABC obtains a $10,000 license that expires in 5 years, it will be labeled as a $2,000 amortization expense each year. Amortization what is amortization in accounting is the process of incrementally charging the cost of an asset to expense over its expected period of use, which shifts the asset from the balance sheet to the income statement. It essentially reflects the consumption of an intangible asset over its useful life.

what is amortization in accounting

Amortization is an accounting technique used to periodically lower the book value of a loan or intangible asset over a set period of time. In relation to a loan, amortization focuses on spreading out loan payments over time. When applied to an asset, amortization is similar to depreciation. These assets benefit the company for many future years, so it would be improper to expense them immediately when they are purchase. Instead, intangible assets are capitalized when purchased and reported on the balance sheet as a non-current asset. In order to agree with the matching principle, costs are allocated to these assets over the course of their useful life.

Calculating The Amortization Of A Loan

The goal in amortizing an asset is to match the expense of acquiring it with the revenue what is amortization in accounting it generates. When a company acquires assets, those assets usually come at a cost.

However, because most assets don’t last forever, their cost needs to be proportionately expensed based on the time period during which they are used. Amortization and depreciation are methods of prorating the cost of business assets over the course of their useful life. Overall, companies use amortization to write down the balance of intangible assets and loans. Similarly, it allows them to spread https://simple-accounting.org/ out those balances over a period of time, allowing for revenues to match the related expense. The fact is that most of a company’s assets, whether tangible or intangible, lose value over time. Those losses are quantifiable, which can have an impact on your business’ accounting practices. When discussing an intangible asset, the process of quantifying gradual losses in value is called amortization.

Amortization Example

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 prepaid expenses to such items as the discount on notes receivable and deferred charges. For example, a company benefits from the use of a long-term asset over a number of years. Thus, it writes off the expense incrementally over the useful life of that asset.

what is amortization in accounting