AMORTIZATION

Usually referred to the decrease in accounting value over time of an asset or, conversely, the periodic payment of a liability. Also known as depreciation (assets), redemption (bonds), refunding, repayment (liabilities), reimbursement. Whether talking about an asset or liability, to amortize means to liquidate, extinguish, pay-off or write-off gradually.

Amortization of an asset. This means the depreciating accounting value of an asset over time. This happens with any acquired asset that is accounted for. When a business purchases a good, the good will have a useful “lifetime” for many years, so it would be incorrect to assign the expenditure to just one year. Therefore, the expenditure (cost that was paid) is divided among the number of years or months of the life of the good so as not to affect the balance sheet in such a direct way.

The amortization is one of the most important factors when valuing a good since the value of a good on a certain date is calculated by taking the price at acquisition and subtracting both the accumulated amortization and the value it may retain at the end of its useful “lifetime” (called the residual value). Amortization of a liability. This type of amortization means that you are paying off a liability that was contracted in the past, thereby reducing the debt that you owe on a loan, mortgage or another type of product (credit card balance scheduled payment). Each payment represents a part of the capital or credit that was contracted plus an amount of added interest.

There are many different types of amortization, but these are the most common types of amortization schedules:

  • Straight line (linear): the quota (or amount to be paid) is constant throughout the whole period of time.
  • Declining balance: the quota is progressively less and less.
  • Annuity: a stream of fixed payments that ends after a specific period of time.
  • Bullet: paying all at once.
  • Balloon: making regular payments and one big final payment.
  • Increasing balance: the quota is progressively more and more.