Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Amortization

What it is:

Amortization is an accounting term that refers to the process of allocating the cost of an intangible asset over a period of time. It also refers to the repayment of loan principal over time.

How it works (Example):

Let's assume Company XYZ owns the patent on a piece of technology, and that patent lasts 15 years. If the company spent $15 million to develop the technology, then it would record $1 million each year for 15 years as amortization expense on its income statement.

Alternatively, let's assume Company XYZ has a $10 million loan outstanding. If Company XYZ repays $500,000 of that principal every year, we would say that $500,000 of the loan has amortized each year.

Why it Matters:

The length of time over which various intangible assets are amortized vary widely, from a few years to as many as 40 years.  As a general rule, an asset should be amortized over its estimated useful life, or the maturity or loan period in the case of a bond or a loan.  If an intangible asset has an indefinite life, such as goodwill, it cannot be amortized.

It is important to note that the term amortization refers to intangible assets; the term depreciation refers to tangible assets, and the term depletion refers to natural resources.

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