Amortization Accounting Definition

It is the concept of incrementally charging the cost (i.e., the expenditure required to acquire the asset) of an asset to expense over the asset’s useful life. For example, capitalization is the action of amortizing or depreciating an asset or expense over a period of time other than when the expense took place. This expense is found both on the Income Statement and the Cash Flow Statement. Expensing off asset balances is most useful for a company that deducts the expense from its taxable income.

You may need a small business accountant or legal professional to help you. Amortization is used to charge the value of intangible assets to expense, while depreciation performs the same function for tangible assets. Amortization is usually conducted on a straight-line basis, while depreciation may be accelerated. Another difference is that the IRS indicates most intangible assets have a useful life of 15 years. For example, computer equipment can depreciate quickly because of rapid advancements in technology.

What is the difference between amortization and depreciation?

This shifts the asset to the income statement from the balance sheet. The term ‘depreciate’ means to diminish something value over time, while the term ‘amortize’ means to gradually write off a cost over a period. Conceptually, depreciation is recorded to reflect that an asset is no longer worth the previous carrying cost reflected on the financial statements.

Some examples of fixed or tangible assets that are commonly depreciated include buildings, equipment, office furniture, vehicles, and machinery. An amortization schedule is often used to calculate a series of loan payments consisting of both principal and interest in each payment, as in the case of a mortgage. Though different, the concept is somewhat similar; as a loan is an intangible item, amortization is the reduction in the carrying value of the balance.

Tax and accounting regions

The historical cost of fixed assets remains on a company’s books; however, the company also reports this contra asset amount as a net reduced book value amount. Almost all intangible assets are amortized over their useful life using the straight-line method. This means the same amount of amortization expense is recognized each year. On the other hand, there are several depreciation methods a company can choose from. These options differentiate the amount of depreciation expense a company may recognize in a given year, yielding different net income calculations based on the option chosen.

  • Depreciation is the expensing of a fixed asset over its useful life.
  • The difference between amortization and depreciation is quite simple.
  • Only to the extent related to the current financial year, the remaining amount is shown in the balance sheet as an asset.
  • Second, amortization can also refer to the practice of spreading out capital expenses related to intangible assets over a specific duration—usually over the asset’s useful life—for accounting and tax purposes.
  • However, you might also incur brighter total interest costs over the total lifespan of the loan.

Sage makes no representations or warranties of any kind, express or implied, about the completeness or accuracy of this article and related content. With NetSuite, you go live in a predictable timeframe — smart, stepped implementations begin with sales and span the entire customer lifecycle, so there’s continuity from sales to services to support. Residual value is the amount the asset will be worth after you’re done using it. This method can significantly impact the numbers of EBIT and profit in a given year; therefore, this method is not commonly used. Consider the following example of a company looking to sell rights to its intellectual property.

Amortization Meaning: Definition and Examples

Amortization helps businesses and investors understand and forecast their costs over time. In the context of loan repayment, amortization schedules provide clarity into what portion of a loan payment consists of interest versus principal. This can be useful for purposes such as deducting interest payments for tax purposes. Amortizing intangible assets is also important because it can reduce a company’s taxable income and therefore its tax liability, while giving investors a better understanding of the company’s true earnings. In accounting, the amortization of intangible assets refers to distributing the cost of an intangible asset over time.

Amortization Accounting Definition

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