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Amortisation definition

A lender typically allows a loan to be repaid over time. The calculation of a loan repayment is determined over months, or years. Whenever amortisation is conducted, the precise loan repayment terms and conditions are determined by the lender, bank, or loan issuer. Whenever amortisation is involved, interest on the principal amount of the loan is due. This is also worked into the repayment schedule. Amortisation refers to the cost of intangible assets, or the repayment of the loan over time. It covers intangible assets such as copyrights, trademarks, and patents. Depreciation is associated with a tangible asset such as vehicles, machinery, equipment, furniture, real estate, et cetera.

Amortisation is paid in fixed instalments. For example, if you finance a vehicle, you will repay the cost of the loan over a period of time, typically five years. The instalment amounts are steady from inception to completion. Once the debt has been repaid, the loan obligation is over and the asset in question is yours. This differs considerably from depreciation. With depreciation, more is paid upfront in the borrowing period, and less towards the end. The reason for this is clear: the more an asset is used, the quicker it depreciates. The amortisation accounting method lowers the book value of the intangible asset, or the loan, over time. It effectively spreads out the loan payment amount.

Amortisation: Paying Off Debt and Spreading Capital Expenses

Amortisation references two unique situations. The first of these is the repayment of debts using principal and interest payments over time. To do this, an amortisation schedule is determined. This reduces the outstanding balance on a loan such as a car loan, or a home mortgage. Instalment payments are calculated over the lifetime of the loan, in equal increments. The second reference to amortisation is the spreading of capital expenses for intangible assets such as patents, copyrights, licences et al over time. This is done for accounting/tax purposes. The calculation for amortisation is as follows:

  • Principle Payment = Total Monthly Payment – (Outstanding Loan Balance X (Interest-Rate/12 Months))

Nowadays, amortisation figures are calculated with online amortisation calculators, scientific calculators, and software packages/programs. The amortisation amount begins with the total amount of the loan. Once the monthly payment amounts (principal + interest) have been determined, these are fixed for the duration of the loan repayment. With each successive repayment, the remaining loan balance is determined. For example: The prior month’s balance – the recent principal repayment. The interest is calculated from the new outstanding balance. This continues over the duration of the loan until all the payments have been paid up. By the end, the loan amount and the interest outstanding are zero. 

How Amortisation Works with Intangible Assets

Intangible assets include copyrights, patents, licences, trademarks, or goodwill. Amortisation also exists with intangible assets. It is the expensing of these assets over their lifespan. Amortisation is calculated in a similar fashion to depreciation for tangible assets. When companies utilise long-term assets for many years, the expenses associated with those assets are incrementally written off over the lifetime of that asset. Amortisation of intangibles is helpful with tax planning. Deductions are permitted by the IRS for specific expenses such as trademarks, copyrights, patents, and goodwill. Schedules determine the total number of years for writing off expenses on tangible and intangible assets.

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