Definition of Amortization
In general, the word amortization means to systematically reduce a balance over time. In accounting, amortization is conceptually similar to the depreciation of a plant asset or the depletion of a natural resource.
Examples of Amortization
Perhaps the most common example of the term amortization is the amortization schedule associated with a mortgage loan. For a 15-year mortgage loan with a fixed interest rate and monthly payments, the amortization schedule shows the same total amount for each of the monthly payments. However, since each month's principal payment reduces the loan's principal balance, the next month's interest payment will be slightly less and the principal payment slightly more.
In addition to the amortization schedule for loans payable and loans receivable, accountants use the term amortization to mean the systematic allocation of an asset or liability amount from the balance sheet to expense (or revenue) on the income statement. Here are a few examples:
- The debit balance in the contra liability account Discount of Bonds Payable will be amortized to Interest Expense over the life of the bonds. (The accountant credits Discount on Bonds Payable and debits Bond Interest Expense with a portion of the balance each accounting period.)
- The credit balance in the liability account Premium on Bonds Payable will be amortized over the life of the bonds by debiting Premium on Bonds Payable and crediting Interest Expense.
- The credit balance in the contra asset account Discount on Notes Receivable will be amortized by debiting Discount on Notes Receivable and crediting Interest Income.
- The debit balances in some of the intangible asset accounts will be amortized to expense over the estimated life of the intangible asset.