What is amortization?
The word amortization has two common meanings in finance and accounting.
1. Amortization of intangible assets
Intangible assets with a finite life (software licences, patents, trademarks, customer lists, franchise rights) are expensed gradually over their useful life, much like depreciation for physical assets. It is usually straight-line.
Annual amortization = (Cost − Residual value) ÷ Useful life
Intangibles with an indefinite life, such as goodwill under IFRS, are not amortised but tested for impairment each year. The rules are in IAS 38 Intangible Assets.
2. Loan amortization
An amortizing loan is repaid in regular instalments. Early payments are mostly interest; later payments are mostly principal. An amortization schedule shows the split for every payment.
Example
A business pays $12,000 for a three-year software licence. It records $4,000 of amortization expense each year: debit amortization expense, credit accumulated amortization.
Why it matters
- Matches the cost of long-lived intangibles to the periods that benefit.
- Amortization is non-cash, so it is added back in EBITDA and the cash flow statement.
- Tax rules for amortizing intangibles may differ from accounting rules.