Amortization is a financial practice of showing the cost of intangible assets over its usable life and not just mentioning them in the books as a one time expense. These assets can be like software, trademarks, patents, and more that are beneficial in the long run.
This term is very familiar in financing, where EMIs are made over an agreed tenure with interest and principal. Hence, you can use amortization for both assets accounting and loan facility.
How It Works:
- A loan is taken for a fixed tenure.
- A repayment schedule (amortization schedule) is created.
- Each payment includes:
- Interest (higher in early stages)
- Principal (increases over time)
- The loan balance reduces with each payment.
- The loan is fully repaid by the end of the term.
Benefits:
- Provides predictable repayment structure
- Helps in financial planning and budgeting
- Gradually reduces debt burden
- Commonly used for business loans and asset financing
Example:
A company buys a patent for Rs 10 lakh and expects to use it for 10 years. Instead of recording the full amount as a one time expense, it records ₹1 lakh as an amortization expense each year for 10 years.