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Amortization vs Depreciation: What’s the Difference?

Amortization Accounting Definition and Examples

After the calculations, you would end up with a monthly payment of around $664. A portion of that monthly payment is going to go directly to interest and the remaining will go directly towards the principal. However, the amount that goes towards principal will increase as the amount of interest decreases. You are also going to need to multiply the total number of years in your loan term by 12.

Amortization Accounting Definition and Examples

A loan is amortized by determining the monthly payment due over the term of the loan. The IRS has schedules that dictate the total number of years in which to expense tangible and intangible assets for tax purposes. The most common method of amortization is straight-line amortization, where an equal amount is amortized each year. Other methods include reducing balance amortization, declining balance method, and double declining balance method. Amortization typically utilizes the straight-line method, where the cost of the asset is evenly spread over its useful life. In contrast, depreciation offers various methods such as straight-line, reducing balance, and double declining balance, allowing for different patterns of expense allocation.

Examples of Intangible Assets

In general, longer depreciation periods include smaller monthly payments and higher total interest costs over the life of the loan. This schedule is quite useful for properly recording the interest and principal components of a loan payment. Amortizing intangible assets is essential for tax planning and complying with generally accepted accounting principles (GAAP). It helps tie the cost of using an asset to the revenues it generates in the same accounting period. Amortization in accounting refers to the distribution of the cost of an intangible asset over time using a fixed amortization schedule. This helps reduce taxable income throughout the lifespan of the asset.

Amortization Accounting Definition and Examples

The goodwill impairment test is an annual test performed to weed out worthless goodwill. Using this method, an asset value is depreciated twice as fast compared with the straight-line method. This linear method allocates the total cost amount as the same each year until the asset’s useful life is exhausted. Amortization can be an excellent tool to understand how borrowing works. It can also help you budget for larger debts, such as car loans or mortgages.

Guide to Understanding Accounts Receivable Days (A/R Days)

If an intangible asset has an unlimited life, then it is still subject to a periodic impairment test, which may result in a reduction of its book value. Amortization schedules can be customized based on your loan and your personal circumstances. With more sophisticated amortization calculators you can compare how making accelerated payments can accelerate your amortization.

In the course of a business, you may need to calculate amortization on intangible assets. In that case, you may use a formula similar to that of straight-line depreciation. These assets can contribute to the revenue growth of your business. An example of an intangible asset is when you buy a copyright for an artwork or a patent for an invention.


Amortized loans are also beneficial in that there is always a principal component in each payment, so that the outstanding balance of the loan is reduced incrementally over time. For example, if your annual interest rate is 3%, then your monthly interest rate will be 0.25% (0.03 annual interest rate ÷ 12 months). For example, a four-year car loan would have 48 payments (four years × 12 months). As premiums are gradually amortized, it affects how interest income from these bonds is recognized over time. Initially, when a bond is purchased at a premium, only part of each interest payment represents actual interest income.

  • In the first month, $75 of the $664.03 monthly payment goes to interest.
  • Understanding how this principle works will enable you to navigate these areas more effectively, whether you are involved in accounting, investments, or loans.
  • Organizations can effectively manage their investments and optimize returns by calculating premium amortization for bonds sold before maturity.
  • Following guidelines set by organizations like GAAP ensures consistent treatment of amortization across industries and facilitates meaningful comparisons between companies.
  • The difference between the purchase price and the face value is known as the premium.

Your payment should theoretically remain the same each month, which means more of your monthly payment will apply to principal, thereby paying down over time the amount you borrowed. Different calculation methods are used to determine the amortization schedule for premium bonds before their maturity dates. One standard method is the straight-line method, where an equal amount of premium is amortized each period until it reaches zero by maturity.

The Amortization Schedule Formula:

This means more depreciation expense is recognized earlier in an asset’s useful life as that asset may be used heavier when it is newest. Tangible assets can often use the modified accelerated cost recovery system (MACRS). Meanwhile, amortization often does not use this practice, and the same amount of expense is recognized whether the intangible asset is older or newer. Let’s say, it’s the 25-year loan you can take, but you should fix your 20-year loan payments (assuming your mortgage allows you to make prepayments). You could just change your monthly payments without a penalty for 25 years if you are ever faced with financial difficulties. In a loan amortization schedule, this information can be helpful in numerous ways.