 |
 |
|
|
AmortizationAmortization is a term used for an accounting procedure by which, loans and intangible asset values are systematically reduced to zero in books, over usually but not necessarily, a long period of time. In business, it would mean repayment of entire loan in regular installments over a stipulated period of time, say 15 years.
When a business enterprise buys out another business enterprise, it pays for copyrights, patents, intellectual property, etc ., which are intangible assets, as they cannot be perceived physically . However, perceivable benefits do accrue from such intangible assets . These intangible assets have a limited lifespan, for example patents, which have a fixed expiry period. Therefore, such assets of the acquired business are written off annually till their value become zero in the accounting books. Here, it becomes necessary to differentiate amortization with depreciation . Depreciation is writing off of the value of tangible asset to the extent it is utilized in each year, over the asset\'s life. Amortization, on the other hand is essentially writing off of intangible assets or indebtedness (generally in mortgage loans) over a long period.
Loans could be repaid in straight line method, or reducing balance method, or through an annual payment, or in its entirety at one go . For example, a business enterprise borrows $1,000,000 . The loan is to be repaid over a period of 15 years . The business enterprise will repay $66,666.66 annually towards the loan principal . In addition, it will also pay interest as per terms of the loan on principal outstanding at the beginning of each of those 15 years . At the end of the 15th year, entire loan liability will be extinguished. Consequently, the business enterprise will no longer incur any interest expenditure on the loan, nor pay any further installments of loan. The declining balance variant of this loan is found in home loans .
Unlike the above example, where the quantum of loan repaid annually is fixed at $66,666.66, and interest keeps on varying, home loans have equated monthly installments. This monthly installment is a fixed amount comprised partly of interest and partly of loan principal, which is paid regularly every month throughout the period of loan. The interest component in the monthly installment comes down every month as the principal is reduced every month. Effectively, in the initial stages of home loan, borrower pays out larger amount towards applicable interest, and a much smaller amount towards the repayment of loan principal. After about half of the home loan tenure, loan principal component in this fixed monthly installment starts overtaking the interest component . Another interesting aspect of home loans is ballooning . Sometimes the borrowers expect to receive some amounts from other sources, like maturity of deposits, insurances, etc., during the loan tenure. These help the borrower in repaying the loan faster . Alternatively, the borrower becomes eligible to borrow more based on such anticipated receipts. On the whole, amortization process makes homes affordable.
Amortization is an accounting procedure that is used all over the world . Consequently, there is a need for some uniformity, which is brought about by International Accounting Standard 38 for intangible assets. In United States, treatment of amortization in accounts is a topic covered by generally accepted accounting principles (GAAP)\'s Statement of Accounting Standards No .142, Goodwill and Other Intangible Assets.
Other articles
|
