Amortization
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In business terms, amortization refers to the allocation of a particular lump-sum cash flow into several lesser cash flow installments based on the amortization schedule. In this form of repayment of installment, both the principal and interest are taken into account. Amortization is primarily used in cases of loan repayments like a mortgage loan as well as in sinking funds. Payments are distributed into equal amounts throughout the loan’s tenure thus making it one of the most simple repayment models. Amortization entails greater payment amount applicable towards interest at the start of the amortization schedule, whereas more amount is directed towards payment of the principal towards the end of the loan’s tenure.
The formula for amortization calculation is: P = A x [1-{1/(1+r)}]n/r
P refers to the borrowed amount or the principal, A is the payment to be made periodically, r is the periodic rate of interest which is divided by 100, and n refers to the number of payments (monthly) to be made for a 30 year loan period.
Negative amortization takes place if payments are not adequate to cover the interest that is due. The interest keeps getting added to the outstanding loan amount thus making the loan even heavier.
In accounting terms, amortization is expensing the cost of acquisition without the intangible assets residual value in an organized manner, throughout their predicted years of usefulness.
What is the difference between amortization and depreciation?
Both amortization and depreciation are utilized in order to prorate the particular asset’s cost to the asset’s estimated life.
Amortization, as has been explained above is systematic distribution of cost of an intangible asset throughout the assets tenure of usefulness. Thus a patent over a medical instrument generally lasts for 17 years. The cost incurred while creating that instrument is evenly distributed throughout the patent’s life, with every part being taken as a cost incurred on the company’s income record.
Depreciation, on the contrary is prorating the cost of a tangible asset throughout the life of that asset. Thus an office building may be used for several years prior to it being run down or being sold off. The building cost is distributed throughout the estimated life of that building, with a part of the expense or cost being recorded every accounting year.
Amortization table
An amortization table usually contains the following information:
• The payment to be made
• Impact of the rate of interest on the amount of loan
• The borrower’s stand in relation to the loan any time in future
• The effect of a fluctuation of interest in case of a variable rate of interest loan
There are several benefits of creating an amortization table. You will be able have the facts and figures right before your eyes which will help prevent over stepping your limits. The amortization table will help you to locate any hidden charges, if any. The table will also be of great help in bargaining with the finance or sales person who will know that you do understand and are keeping track of the intricacies.