Amortization (business)

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For other uses of Amortization, see the Amortization disambiguation page.

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Amortization is the distribution of a single lump-sum cash flow into many smaller cash flow installments, as determined by an amortization schedule. Unlike other repayment models, each repayment installment consists of both principal and interest. Amortization is chiefly used in loan repayments (a common example being a mortgage loan) and in sinking funds. Payments are divided into equal amounts for the duration of the loan, making it the simplest repayment model. A greater amount of the payment is applied to interest at the beginning of the amortization schedule, while more money is applied to principal at the end.

The amortization calculator formula is: (1-vⁿ)÷r, where n = number of years, v = 1÷(1+r), and r = interest rate ÷ 100. See also time value of money.

Divide by (1+r) if a payment is due at the beginning.

Another method of writing this kind of formula is:

<math>P \,=\,A\cdot\frac{1-\left(\frac{1}{1+r}\right)^n}{r}</math>

where: P = principal amount borrowed, r = periodic interest rate (annual interest rate divided by 12 in case of monthly installments), n = total number of payments (for a 30-year loan with monthly payments, n = 30 years × 12 months = 360), and A = periodic payment.

Negative amortization (also called deferred interest) occurs if the payments made do not cover the interest due. The remaining interest owed is added to the outstanding loan balance, making it larger than the original loan amount.

[edit] Accounting

In accounting, amortization refers to expensing the acquisition cost less the residual value of intangible assets (often intellectual property [IP] such as patents and trademarks or copyrights) in a systematic manner over their estimated useful economic lives so as to reflect their consumption, expiration, obsolescence or other decline in value as a result of use or the passage of time.

A corresponding concept for tangible assets is depreciation. Methodologies for allocating amortization to each accounting period are generally the same as for depreciation. However, many intangible assets such as goodwill or certain brands may be deemed to have an indefinite useful life and are therefore not subject to amortization.

Amortization is recorded in the financial statements of an entity as a reduction in the carrying value of the intangible asset in the balance sheet and as an expense in the income statement.

Under International Financial Reporting Standards, guidance on accounting for the amortization of intangible assets is contained in International Accounting Standard 38, Intangible Assets. Under United States generally accepted accounting principles (GAAP), the primary guidance is contained in Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets.