Amortization
Last reviewed 2026-05-11 by Asad Ali, Founder & CEO
The gradual reduction of a loan balance or spreading the cost of an intangible asset over its useful life.
Amortization has two meanings. For intangible assets (patents, trademarks, customer lists, capitalized software), it spreads acquisition cost over useful life as an expense — similar to depreciation for tangible assets. Under US GAAP, most acquired intangibles with a finite life are amortized straight-line; goodwill is not amortized but tested for impairment. For tax purposes, IRC Section 197 generally requires acquired intangibles to be amortized over 15 years regardless of expected life. For loans, amortization refers to paying down principal through scheduled level payments. In early payments, interest dominates; over time, more of each payment reduces principal. An amortization schedule shows the principal-interest split for every payment over the life of the loan.
Formula
Annual Amortization (Intangible Asset) = (Cost − Residual Value) ÷ Useful Life. Loan Payment = P × [r(1+r)^n] ÷ [(1+r)^n − 1], where r is the periodic rate and n is the number of periods.Example
A software company acquires a patent for $50,000 with a 10-year useful life. Annual amortization = $50,000 ÷ 10 = $5,000 per year. After 4 years, accumulated amortization is $20,000 and the patent's book value is $30,000. On a $200,000 5-year loan at 6%, the monthly payment is roughly $3,867 — in month 1, ~$1,000 is interest and $2,867 is principal; by month 60, almost the entire payment goes to principal.
Why It Matters for Your Business
Amortization affects reported expenses and asset values, and for loans, understanding the schedule helps you plan payments and total interest cost.
Practical Tips
- •Amortize acquired intangibles separately from internally developed ones — internally developed intangibles are usually expensed as incurred under GAAP
- •Use Section 197 (15-year) amortization for goodwill and most acquired intangibles for tax purposes, even if book life differs
- •Generate a full loan amortization schedule before signing — total interest over the life of the loan is often shocking
- •Make extra principal-only payments early in a loan's life for the biggest interest savings
Common Questions About Amortization
How is amortization calculated?
The formula is: Annual Amortization (Intangible Asset) = (Cost − Residual Value) ÷ Useful Life. Loan Payment = P × [r(1+r)^n] ÷ [(1+r)^n − 1], where r is the periodic rate and n is the number of periods.. See the worked example below for a step-by-step calculation using realistic numbers.
What is an example of amortization?
A software company acquires a patent for $50,000 with a 10-year useful life. Annual amortization = $50,000 ÷ 10 = $5,000 per year. After 4 years, accumulated amortization is $20,000 and the patent's book value is $30,000. On a $200,000 5-year loan at 6%, the monthly payment is roughly $3,867 — in month 1, ~$1,000 is interest and $2,867 is principal; by month 60, almost the entire payment goes to principal.
Why does amortization matter for my business?
Amortization affects reported expenses and asset values, and for loans, understanding the schedule helps you plan payments and total interest cost.
How does FiscalInsights help with amortization?
FiscalInsights tracks amortization automatically as part of its AI bookkeeping workflow. Connect your bank accounts and the platform handles categorization, reconciliation, and reporting without manual entry.
Related Terms
More Accounting Terms
Accounts Payable
Money owed by a business to its suppliers or creditors for goods or services received but not yet paid for.
Accounts Receivable
Money owed to a business by its customers for goods or services delivered but not yet paid for.
Accrual Accounting
An accounting method that records revenues and expenses when they are incurred, regardless of when cash is exchanged.
Asset
Any resource owned by a business that has economic value and can provide future benefits.
Balance Sheet
A financial statement showing assets, liabilities, and equity at a specific point in time.
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