What is Amortization?
There are two general definitions of amortization. The first is the systematic repayment of a loan over time. The second is used in the context of business accounting and refers to the act of spreading the cost of an expensive, long-lived item over many periods. Both are explained in more detail below.
Paying Off a Loan Over Time
When a borrower takes out a mortgage, car loan, or personal loan, they usually make monthly payments to the lender — these are some of the most common uses of amortization. A part of each payment covers the interest due on the loan, and the remainder goes toward reducing the principal amount owed. Interest is computed on the current outstanding balance, so it becomes progressively smaller as the principal decreases. This can be observed clearly in the amortization table.
Credit cards, on the other hand, are generally not amortized. They are an example of revolving debt, where the outstanding balance can be carried month-to-month and the amount repaid each month can vary. Other examples of non-amortized loans include interest-only loans (which include an interest-only payment period) and balloon loans (which have a large principal payment at loan maturity).
Amortization Schedule
An amortization schedule (sometimes called an amortization table) is a table detailing each periodic payment on an amortizing loan. Each repayment contains both an interest payment and a payment toward the principal balance, which varies for each pay period. An amortization schedule helps indicate the specific amount paid toward each component, along with the cumulative interest and principal paid to date and the remaining principal balance after each pay period.
Basic amortization schedules do not account for extra payments, but borrowers can still pay extra toward their loans to reduce the principal faster and save on interest. It is also worth noting that amortization schedules generally only apply to fixed-rate loans and do not account for adjustable-rate mortgages, variable-rate loans, or lines of credit.
Spreading Costs (Business Accounting)
Certain businesses purchase expensive items — such as machinery, buildings, and equipment — that are used over long periods and classified as investments. From an accounting perspective, recording the full cost of a large asset in a single period can distort financial statements, so its value is amortized (spread) over the expected useful life of the asset. Although technically a form of amortization, this process is more commonly referred to as the depreciation of a physical asset.
Amortization in accounting more specifically refers to intangible assets such as patents, copyrights, and trademarks. Just like with loan repayment, payment schedules for asset amortization can be planned using an amortization schedule. Common intangible assets that are often amortized include:
- Goodwill — the reputation of a business regarded as a quantifiable asset
- Going-concern value — the value of a business as an ongoing entity
- Workforce in place — the value of existing employees, including experience, education, and training
- Business records and operating systems — including databases, customer lists, and information bases
- Patents, copyrights, and formulas — processes, designs, patterns, know-hows, or similar items
- Customer-based intangibles — customer bases and established customer relationships
- Supplier-based intangibles — the value of future purchases due to existing vendor relationships
- Government-granted licenses and permits — including issuances and renewals
- Non-compete agreements — covenants entered relating to acquisitions of business interests
- Franchises, trademarks, and trade names
- Contracts — for the use of or term interests in any of the above intangible items
Note: Some intangible assets — most notably goodwill with an indefinite useful life or those that are "self-created" — may not be eligible for tax amortization under the laws of certain jurisdictions.
Amortizing Startup Costs
Business startup costs are generally defined as costs incurred to investigate the potential of creating or acquiring an active business, or costs incurred to create an active business. Examples include consulting fees, financial analysis of potential acquisitions, advertising expenditures, and employee training costs — all of which must typically be incurred before the business is considered operational. Many tax authorities permit these startup costs to be amortized over a set period rather than deducted in full in the year they are incurred. The specific rules vary by jurisdiction, so businesses should consult a qualified tax professional or accountant to understand the applicable regulations in their region.