Definition
Amortization is the systematic allocation of a cost or repayment amount over a period of time.
It could be used in two places:
Valuation of intangible assets
Valuation of the remaining loan
What does amortization of intangible assets mean?
When a company purchases an asset, that asset is used to generate benefits over many years. As it is used, the value of the asset gets consumed over time. Instead of recognizing the entire cost immediately, accounting gradually writes off the asset's cost over its useful life.
Intangible assets lose value because their legal life expires, the version expires, technology becomes obsolete, or their economic benefits are gradually consumed. Therefore, their cost is systematically written off over time through amortization.
Example:
So, if we take an example, let’s assume that a company buys a patent for ₹10 crore.
The patent will help the company earn money for the next 10 years. So, we cannot assume that the benefit is recovered in just 1 year.
The benefit of the patent is being received over 10 years, so the cost should also be recognized over 10 years.
Therefore, accounting says:
Year 1: Expense ₹1 crore
Year 2: Expense ₹1 crore
Year 3: Expense ₹1 crore
...
Year 10: Expense ₹1 crore
This gradual write-off of the patent's cost is called amortization.
What is loan amortization?
When a person or company takes a loan, they receive a lump sum amount upfront. That loan becomes a liability that must be repaid over time.
Instead of repaying the entire amount at once, the borrower makes periodic payments. Each payment consists of two parts:
Interest (the cost of borrowing)
Principal (repayment of the original loan amount)
As the principal is gradually repaid, the outstanding loan balance keeps reducing over time.
This gradual reduction of the loan balance through scheduled payments is called loan amortization.
Example:
Suppose you take a loan of ₹1,00,000 at 12% annual interest and agree to pay ₹10,000 every month.
At the start:
Loan balance = ₹1,00,000
After one month:
Interest = 1% × ₹1,00,000 = ₹1,000
EMI paid = ₹10,000
Out of the ₹10,000 payment:
₹1,000 goes toward interest
₹9,000 goes toward repaying the loan
New loan balance:
₹1,00,000 − ₹9,000 = ₹91,000
After the second month:
Interest = 1% × ₹91,000 = ₹910
EMI paid = ₹10,000
Out of the ₹10,000 payment:
₹910 goes toward interest
₹9,090 goes toward repaying the loan
New loan balance:
₹91,000 − ₹9,090 = ₹81,910
As the loan balance gets smaller:
Interest becomes smaller.
More of the EMI goes toward repaying the principal.
The outstanding loan gradually falls to zero.
This gradual reduction of the loan balance from ₹1,00,000 to ₹0 through regular payments is called loan amortization.
Definition
Amortization is the systematic allocation of a cost or repayment amount over a period of time.
It could be used in two places:
Valuation of intangible assets
Valuation of the remaining loan
What does amortization of intangible assets mean?
When a company purchases an asset, that asset is used to generate benefits over many years. As it is used, the value of the asset gets consumed over time. Instead of recognizing the entire cost immediately, accounting gradually writes off the asset's cost over its useful life.
Intangible assets lose value because their legal life expires, the version expires, technology becomes obsolete, or their economic benefits are gradually consumed. Therefore, their cost is systematically written off over time through amortization.
Example:
So, if we take an example, let’s assume that a company buys a patent for ₹10 crore.
The patent will help the company earn money for the next 10 years. So, we cannot assume that the benefit is recovered in just 1 year.
The benefit of the patent is being received over 10 years, so the cost should also be recognized over 10 years.
Therefore, accounting says:
Year 1: Expense ₹1 crore
Year 2: Expense ₹1 crore
Year 3: Expense ₹1 crore
...
Year 10: Expense ₹1 crore
This gradual write-off of the patent's cost is called amortization.
What is loan amortization?
When a person or company takes a loan, they receive a lump sum amount upfront. That loan becomes a liability that must be repaid over time.
Instead of repaying the entire amount at once, the borrower makes periodic payments. Each payment consists of two parts:
Interest (the cost of borrowing)
Principal (repayment of the original loan amount)
As the principal is gradually repaid, the outstanding loan balance keeps reducing over time.
This gradual reduction of the loan balance through scheduled payments is called loan amortization.
Example:
Suppose you take a loan of ₹1,00,000 at 12% annual interest and agree to pay ₹10,000 every month.
At the start:
Loan balance = ₹1,00,000
After one month:
Interest = 1% × ₹1,00,000 = ₹1,000
EMI paid = ₹10,000
Out of the ₹10,000 payment:
₹1,000 goes toward interest
₹9,000 goes toward repaying the loan
New loan balance:
₹1,00,000 − ₹9,000 = ₹91,000
After the second month:
Interest = 1% × ₹91,000 = ₹910
EMI paid = ₹10,000
Out of the ₹10,000 payment:
₹910 goes toward interest
₹9,090 goes toward repaying the loan
New loan balance:
₹91,000 − ₹9,090 = ₹81,910
As the loan balance gets smaller:
Interest becomes smaller.
More of the EMI goes toward repaying the principal.
The outstanding loan gradually falls to zero.
This gradual reduction of the loan balance from ₹1,00,000 to ₹0 through regular payments is called loan amortization.