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Amortisation

Reviewed by Bhavana | Updated on Oct 05, 2020

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Introduction to Amortisation

Amortisation is an accounting strategy used to regularly reduce a loan's book value or an intangible asset's book value over a given period of time.

The term "amortisation" can apply to two circumstances. Firstly, in the process of paying off debt by daily payments of principal and interest over time. The amortisation plan is used by interest payments to reduce the existing balance on loan, for example, a mortgage or a car loan.

Secondly, amortisation may also refer to the outspread of capital expenses related to intangible assets over a fixed period, usually over an asset's useful life, for accounting and tax-related purposes.

Let Us Understand Amortisation in Detail

Amortisation can refer to a process of clearing debt over time in daily interest and principal instalments that are necessary to repay the loan in full by its due date. For mortgage and car loan instalments, a higher proportion of the monthly flat payment early on in the loan goes to interest.

A larger proportion of the payment goes against the principal of the loan for each subsequent payment. The most popular financial calculators, spreadsheet software packages, such as Microsoft Excel, or online amortisation maps, can be used to measure the amortisation.

Amortisation schedules commence with the pending loan balance. The interest charge is determined for monthly instalments by multiplying the interest rate by the outstanding loan balance and dividing it by twelve. The amount of principal due in a given month is the total monthly payment (a flat sum) minus the month's interest payments.

The unpaid loan balance will be measured as the outstanding balance of the preceding month minus the most recent principal payment. Yet again, the interest payment is measured from the current outstanding amount, and the process continues until all principal payments have been made and the debt amount at the end of the loan period is zero.

How is Amortisation Calculated?

Amortisation is measured in a way that is similar to the depreciation utilised for tangible assets, and the depletion which is utilised for natural resources. As per the generally accepted accounting principles (GAAP), when businesses amortise costs over time, they help tie the cost of using an asset to the profits it produces in the same accounting period.

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