Amortization literally means an act or a process involving gradual writing off the initial cost of an asset. In accounting terms amortization is a technique that lowers the book value of tangible assets or a loan over a period of time which is predetermined. Amortization can also be done to spread out of capital expenses attached to intangible assets over a specific time which is the asset's useful life.
Amortization of Intangible Assets
The second kind of amortization is that of the intangible assets. This kind of amortization involves spreading the cost of the intangible assets over the asset's useful life. This amortization measures the value of consumption or use of the intangible asset. This value could be a patent, copyright, or other such uses. To calculate the amortization for intangible assets the same method is used as is done to calculate the depreciation of tangible assets.
If business expenses are amortized, the price of using the asset is attached to the money generated by it in the same period. This is in line with the GAAP or generally accepted accounting principles. The Internal Revenue Service contains actual schedules that state the time period or years in which both tangible and intangible assets can be expensed for taxation uses. When intangible assets are amortized it is of great help in tax planning. As per the Internal Revenue Service certain expenses such as geophysical and geological expenses towards oil and natural gas exploration, atmospheric pollution control facilities, research and development, acquisition of lease, bond premiums, and intangibles, such as goodwill, patents, copyrights, and trademarks, can be deducted by the taxpayers.
Amortization of Loans
When amortization is done to pay off loans, such as a mortgage or an auto loan, the monthly flat payment is made in a higher percentage towards the interest during the early stage of the loan. And with each of the next payments, a bigger chunk of the payment is made towards the principal.
To calculate the amortization there are a lot of tools available such as software packages using spreadsheets, financial calculators, MS Excel, etc. The schedule for amortization starts with an outstanding loan balance. Interest due for monthly payments can be calculated by multiplication of the outstanding loan balance with interest rate and dividing it by twelve. The principal amount due to be paid in any given month is the interest payment of a particular month subtracted from the flat amount due to the monthly payment.
In the following month, to calculate the loan balance due, the last principal payment is subtracted from the balance due from the previous month. And the interest is calculated from the new balance due. This goes on as a chain till a point is reached when all principal payments are paid in full and balance due to the loan is zero by the time the loan term ends.
If you are in the process of amortizing your loans or intangible assets and are looking for calculation or need hand-holding in the matter, we are happy to help.