Amortization is an accounting technique used to periodically lower the book value of a loan or intangible asset over a set period of time. Concerning a loan, amortization focuses on spreading out loan payments over time. When applied to an asset, amortization is similar to depreciation. The concept also applies to such items as the discount on notes receivable and deferred charges.
The amortization concept is also used in lending, where an amortization schedule itemizes the beginning balance of a loan, less the interest and principal due for payment in each period, and the ending loan balance. The amortization schedule shows that a larger proportion of loan payments go toward paying off interest early in the term of the loan, with this proportion declining over time as more and more of the loan’s principal balance is paid off. This schedule is quite useful for properly recording the interest and principal components of a loan payment.
Difference Between Depreciation and Amortization
Difference between depreciation and amortization.
- It is associated with charging intangible assets to expense over time, and depreciation is associated with charging tangible assets to expense over time.
- Similarly, depletion is associated with charging the cost of natural resources to expense over their usage period.
- Both are two methods of calculating the value for business assets over time.
- A business will calculate this expense amounts to use them as a tax deduction and reduce its tax liability.
- It is the practice of spreading an intangible asset’s cost over that asset’s useful life.
- Depreciation is the expensing of a fixed asset over its useful life.
- A third method for expensing business assets is the depletion method, which is an accrual accounting method used by businesses that extract natural resources from the earth such as timber, oil, and minerals.