Amortization

Definition

Amortization is the process of gradually reducing a debt over time through regular payments that cover both principal and interest. It is commonly used in accounting to allocate the cost of an intangible asset over its useful life.

5 Must Know Facts For Your Next Test

1. Amortization schedules detail each payment's allocation between principal and interest.
2. The effective-interest method calculates interest expense based on the book value of the liability at the beginning of each period.
3. Amortization does not apply to tangible assets; it is specific to intangible assets and certain types of liabilities.
4. Under GAAP, amortized costs must be reviewed for impairment at least annually.
5. Unlike depreciation, which is used for tangible assets, amortization applies to items like patents, trademarks, and goodwill.

Review Questions

• What distinguishes amortization from depreciation?
• How does the effective-interest method affect the calculation of interest expense?
• Why must companies review amortized costs for impairment?

Related terms

Depreciation:

The systematic allocation of the cost of a tangible asset over its useful life.

Effective-Interest Method: A method of allocating interest expense that reflects constant periodic rates of return.

Impairment:

A reduction in the recoverable amount of an asset below its carrying amount.