Amortisation: Spreading Costs Over Time

Amortisation refers to the gradual reduction of a debt or an intangible asset’s value over time. In simple terms, it’s a method of spreading a large cost or loan repayment into smaller, regular payments across a specific period. This helps individuals or companies manage expenses and understand how much of a loan or asset’s value is being “used up” each year.

There are two main uses of amortisation in finance:

Loan Amortisation: When you take out a loan—like a mortgage or car loan—you repay it through regular installments that include both principal (the borrowed amount) and interest. Each payment gradually reduces the total debt until it’s fully paid off by the end of the term.

Asset Amortisation: Businesses also use amortisation to spread the cost of intangible assets—such as patents, trademarks, or software—over their useful life. This helps match expenses with the revenue the asset generates each year.

Example (Loan Amortisation):
Suppose you borrow $10,000 at 5% interest for 5 years. Instead of repaying the full amount at once, you make equal monthly payments that cover both interest and part of the principal. Over time, the interest portion decreases while the principal portion increases, until the loan is fully paid.

Example (Intangible Asset Amortisation):
A company buys a patent worth $100,000 with a useful life of 10 years. Rather than recording the entire cost immediately, it amortises $10,000 each year, reflecting the gradual use of that patent in generating income.

Common Misconceptions and Mistakes:
A frequent confusion arises between amortisation and depreciation. While both spread costs over time, depreciation applies to tangible assets (like buildings or machinery), whereas amortisation applies to intangible ones (like copyrights or licenses). Another mistake is assuming amortisation always reduces taxes — while it can lower taxable income for businesses, it doesn’t always apply to all asset types or personal loans.

Related Queries Investors Often Search For:

What is the difference between amortisation and depreciation?

How is a loan amortisation schedule calculated?

What does full amortisation mean?

Can intangible assets be revalued after amortisation?

Is amortisation a cash or non-cash expense?

In Summary:
Amortisation helps manage costs and repayments by spreading them evenly over time—whether for paying off a loan or writing off an intangible asset. Understanding it is key for both personal finance and business accounting, as it provides a clearer picture of long-term financial obligations and asset value.