The amortization It is the process by which the cost of an asset is distributed throughout its useful life. In financial terms, amortization refers to the gradual decline in value of a loan or one investment over time.
In the case of a loan, the amortization it is used to gradually pay off the balance owed. Each payment made by the borrower includes both the interest earned on the loan and a portion of the principal borrowed, so the balance owed is reduced with each payment.
In the case of an investment, the amortization used to reflect the decline in value of an asset due to wear, obsolescence, or use. This decrease is recorded as a reduction in the book value of the asset in the company's financial statement.
It is important to highlight that the amortization It is a fundamental concept in accounting and financial management, as it allows companies to spread the costs of an investment over its useful life, allowing them to plan their budgets and finances for the long term.
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Types of amortization
There are different types of amortization that are used depending on the type of asset being depreciated. Some of the most common are:
- straight-line amortization: It is an amortization method in which the cost of the asset is distributed equally during its useful life. In this way, an equal amount of money is amortized each year.
- accelerated amortization: In this case, a greater amount of money is amortized during the first years of the useful life of the asset and a smaller amount during the last years. This method is especially useful for assets that depreciate quickly at first and then lose value more slowly.
- variable amortization: It is a method that is used when the useful life of the asset is not exactly known, since the amortization rate is calculated based on its actual performance. For example, if an asset is generating more income than anticipated, the depreciation rate is adjusted to reflect this.
How to calculate amortization
For calculate amortization of an asset, it is necessary to know its acquisition value, its residual value (that is, the value it will have at the end of its useful life) and the period of time during which it will be depreciated. Once these data are available, different amortization calculation formulas can be applied, depending on the method used.
For example, for calculate straight-line depreciation, the cost of the asset is divided by its useful life to obtain the amount of annual depreciation. If the asset has an acquisition value of 10,000 euros and a useful life of 5 years, the annual depreciation amount would be 2,000 euros.
In the case of the amortization accelerated, a double depreciation formula can be used, which allows a greater amount of money to be amortized during the first years. There are also other calculation formulas, such as unit-of-production depreciation, which is used for assets that generate income based on their production.