Amortization is an accounting concept that is used by companies to reduce the book value of a borrowing over a set period. Amortization focuses on distributing or spreading out loan repayments over a period. Amortization helps in reducing a company's taxable income during the entire lifespan of an asset.
Amortization Expense = (Initial Value – Residual Value) / LifespanSuppose a company owns a patent right for 20 years. The company has spent $20,000 for creating the patented product. Thus, it can record $1,000 per year as amortization expense towards the patent ($20,000 / 20 years).
By using the concept of amortization in accounting, businesses can easily know their costs over time. If it's for loan repayment, amortization schedules tell the exact portion of a loan payment classified as interest vs. principal.It is mainly used for tax saving purposes as it allows the deduction of interest payments during the loan tenure.By amortizing intangible assets, a business can reduce its taxable income and overall tax liability. This allows investors to get a better insight into the company's true earnings.
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