What is Amortization?

Definition: Refers to the expensing of intangible capital assets (intellectual property: patents, trademarks, copyrights) in order to reflect their decline in value as a result of use or passage of time. This may be due to consumption, expiration, obsolescence, etc.

Amortization is a systematic allocation of the intangible asset, or the process of paying off a debt over time through regular payments. A corresponding concept for tangible assets is known as depreciation. The idea of Amortization is to spread the cost of the asset over the period of its ‘useful life’.

If the full cost of the asset was recognized in the period it was purchased, then that year’s expenditure would be unfairly overstated while expenditure throughout the remaining years, which were still obtaining benefits from that asset would not be affected and therefore understated.

Fixed assets depreciate for two main reasons:

  1. Wear and tear: i.e; a car will decrease in value because of the wear on tires, body, etc. or because of the mileage, and many other factors.
  2. Obsolescence: Assets often decrease in value as they are replaced by better and newer models. Car model from last year is less valuable this year because a newer model has been released.

Impairment Loss

A loss that represents a permanent decrease in value of the asset.