Firstly, we need to understand “what is amortization?” of assets in order to track the value of assets. Amortization is a routine decrease in value of an intangible asset or the process of paying off a debt over time through regular payments.
Amortization is an accounting technique used to lower the cost value of a finite life or intangible asset incrementally through scheduled charges to income. Amortization is the paying off of debt with a fixed repayment schedule in regular instalments over time like with a mortgage or a car loan.
Amortization usually refers to the expensing of intangible capital assets (intellectual property: patents, trademarks, copyrights, etc.) in order to show their decrease in value as a result of use or the passage of time.
Decreasing value can be the result of consumption, expiration or obsolescence (when a newer model is released).
Amortization and assets
Amortization is most commonly used to describe the routine decrease in value of an intangible asset.
Amortization is like depreciation, which is used for tangible assets, and depletion, which is used for natural resources. When businesses amortize expenses, it helps tie the asset’s costs to the revenues it generates.
A corresponding concept for tangible assets is known as depreciation. The idea of amortization and depreciation is that the cost of an asset is spread over the period of time that it will be of use or its useful life.
If the full price of an asset were to be recognised in the period in which it was purchased, then that year’s expenditure would be overstated incorrectly while expenditures throughout the remaining years, which were still obtaining benefits from that asset, would not be affected and therefore would be understated.
Reasons for value depreciation
• Wear and tear: for example, a car decreases in value over time due to constant wear on the tires, paint job, or because of high mileage, weather damage, etc.
• Obsolescence: Assets frequently decrease in value as they are replaced by new and improved models. For example, a computer loses value if a newer, better model is released.
Amortization and loans
When used in the context of a loan, for example, a small business or bank loan, amortization refers to the repayment of the loan spread out over a series of payments based on a schedule. Initially, the payments mainly cover the interest charges but provide a schedule for total repayment.