Amortization has two primary meanings. In personal finance, amortization refers to a repayment arrangement in which regular payments are made over an extended period of time, such as in a car or home loan . Often in a fixed repayment schedule, earlier payments consist primarily of interest, and the proportion of the payment dedicated to principle increases over time.
Reforestation efforts are one type of expense that may be amortized – Image Credit: Downtowngal (CC by SA-3.0)
In corporate accounting, amortization refers to spreading out the cost of an intangible asset over an extended period of time, usually consisting of the projected life of the asset. In accounting terms, amortization corresponds to intangible assets in the same way depreciation applies to tangible assets and depletion applies to natural resources. For instance, a company might by a patent that has an estimated useful life of 20 years for $40 million. Rather than account for the entire $40 million in the initial year, the cost of the patent can be amortized by spreading out the cost over the 20-year period, recording an expense of $2 million a year. This gives a more realistic picture of the cost of the patent. Amortization is also useful for tax purposes. The IRS allows for deductions for a wide variety of amortized expenses including intellectual property, bond premiums, research and development, pollution control and geological exploration. The IRS also issues schedules that dictate what percentage of an assets cost can be amortized over how many years.
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