Amortization
Spreading the cost of an intangible asset over its useful life, or paying down a loan through scheduled payments of principal and interest.
Definition
Amortization has two related meanings. In accounting, it's the intangible-asset twin of depreciation: spreading the cost of things you can't physically touch—a purchased customer list, a trademark, goodwill from buying another business, certain startup costs—over their useful life. Pay $10,000 for a competitor's client list you expect to benefit from for five years, and you'd amortize it at $2,000 per year.
In lending, amortization describes how a loan gets paid off through a schedule of fixed payments, where each payment covers that month's interest plus a slice of principal. Early payments are mostly interest; later payments are mostly principal. An amortization schedule shows this split for every payment over the life of the loan, which is why the balance on a 5-year loan falls slowly at first and faster near the end.
Why It Matters
The accounting sense matters most when you buy a business or pay significant startup costs—amortization turns those big one-time outlays into deductions spread over several years, and missing it means leaving deductions unclaimed. If you ever sell or acquire a book of clients, how the price gets amortized affects both parties' taxes.
The loan sense matters every time you borrow. Reading an amortization schedule tells you how much of your $800 monthly payment is actually reducing the debt versus going to interest, and what an extra $200 toward principal would save. It also explains why your loan payment isn't a deductible expense in full—only the interest portion is; the principal portion is just returning borrowed money.
Examples
- 1
A designer buys a retiring competitor's client list for $15,000 and amortizes it over five years—a $3,000 deduction each year.
- 2
An agency takes a $50,000 five-year loan at 9%. The amortization schedule shows the first $1,038 payment includes $375 of interest.
- 3
A consultant amortizes $4,000 of LLC formation and startup costs over the IRS-prescribed 15-year period after an initial first-year deduction.
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