Amortization

Amortization has two related meanings in finance.

Amortizing intangible assets

When a business buys or develops an intangible asset with a limited life, such as software, a licence, a patent or a customer list, its cost is recorded on the balance sheet and expensed gradually over its useful life. A $60,000 software licence with a three-year term might be amortized at $20,000 a year. The logic is the same as depreciation for equipment: match the cost to the periods that benefit.

Not every intangible is amortized. Under IFRS and ASPE, goodwill and intangibles with an indefinite life are not amortized; instead, they are tested for impairment and written down if their value falls. Under US GAAP, private companies can elect to amortize goodwill.

Amortizing a loan

A loan is amortized when it is repaid through regular payments that cover both interest and principal. Early payments are mostly interest; later ones are mostly principal. An amortization schedule lists each payment and how it splits, which is also what the bookkeeper uses to record interest expense and reduce the loan balance correctly.

For tax

In Canada, most intangibles are deducted for tax through capital cost allowance classes rather than accounting amortization. The tax and book figures usually differ.