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Amortization: Definition, Method, and Examples in Accounting

In accounting, assets are resources with economic value owned by individuals, companies, or countries with the hope that they will provide benefits in the future. However, the value of the purchased asset is not the same as when it was first purchased. This reduction in asset value is known as amortization. In this article, we will discuss amortization in more detail.

Table of Contents

Amortization Meaning

Amortization is an activity in accounting that gradually reduces the value of an asset with a finite useful life or other intangible assets through a periodic charge to revenue. Some examples that include amortization payments include monthly vehicle loan bills, mortgage loans, KPA loans, credit card loans, patent fees, etc.

Amortization Methods

Straight-line method

This method is a type of amortization calculation by allocating the total cost amount is the same and constant every year until the end of the predetermined useful life. So the straight-line method of amortization is the same every year until the valuable life of the asset is exhausted. An example of a straight-line method is as follows. The calculation of amortization each year is:

In 2020: 20% x $1200 = $240

In 2021: 20% x $1200 = $240

2022: 20% x $1200 = $240

2023: 20% x $1200 = $240

2024: 20% x $1200 = $240

Declining-balance method

The Declining-balance method calculates the declining value of expenses by applying an amortization rate on the remaining book value, and the remaining book value at the end of the useful life must be amortized at once. An example of the declining balance method is as follows. The calculation of amortization each year is:

In 2020: 50% x $1200 = $600

In 2021: 50% x $600 = $300

2022: 50% x $300 = $150

2023: 50% x $150 = $75

2024: 50% x $75 = $37.5, etc.

Difference between Amortization and Depreciation

Besides amortization, accounting also recognizes the term depreciation to refer to the process of reducing the useful value of an asset. The difference between the two is: amortization is a decrease in the value of an intangible asset, whereas depreciation is a decrease in the value of a tangible asset. Suppose amortization reflects the value of the company’s assets when the company wants to resell it. In that case, the depreciation function allows the company to generate and maintain income from these assets for a particular month. Therefore, both amortization and depreciation have a long-term impact on the value of the company’s assets.

Examples of Amortization

Here we provide examples of amortization in everyday life to make it easier to understand. Suppose Company S borrows funds of $10,000, with the installments, Company S must pay $1200 annually. Based on this case study, Company S has amortized loans worth $1200. The second example is when the company has a patent on a product or design for five years. Then to develop the style and design of the product, the company spent $500. Therefore, the company will record the amortization fee at $100 per year for five years of patent ownership.

Conclusion

In conclusion, amortization is an activity in accounting that gradually reduces the value of an asset with a finite useful life or other intangible assets through a periodic charge to revenue. In contrast to depreciation, amortization accounts for intangible assets such as loans and credit cards.

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Anak Agung Istri Karlita Aprilianti
Junior Creative Content Writer at Hashmicro.

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