Amortization is an accounting term used in three circumstances. Its most common use refers to the amortization of a loan or mortgage. The series of loan payments associated with a loan or mortgage, along with the amount of each payment going to interest expense and to repayment of the principal, is known as an amortization schedule. Thus, to amortize a loan is to repay (pay off ) that loan using a series of annuity payments (payments of equal dollar amounts paid over regular intervals of time).
Another use of the term is associated with long-term, intangible assets. While the systematic transfer of a firm’s tangible assets from cost to expense over time is depreciation, the systematic transfer of a firm’s intangible assets from cost to expense is amortization. One of the most fundamental of the generally accepted accounting principles is the matching principle. It requires that a firm’s expenses be matched with the revenues generated. Thus, as the intangible assets of a firm generate revenue (or some benefit), a portion of their costs must be amortized—that is, systematically transferred to expense, in this case amortization expense.
Amortization is also encountered in the accounting for non-interest-bearing notes payable. When funds are obtained with a non-interest-bearing note, the proceeds from that note are less than the face value of the note, requiring the creation of an account called Discount on Note Payable, a contra liability. The account Discount on Note Payable is amortized over the life of the note as interest expense accrues on the borrowed funds.
See also depreciation, depletion, amortization.