What is Amortization?

Amortization is the process of incrementally charging the cost of an asset to expense over its expected period of use. Doing so incrementally shifts the recorded amount of an asset from the balance sheet to the income statement of a reporting entity. It essentially reflects the consumption of an intangible asset over its useful life. Amortization is most commonly used for the gradual write-down of the cost of those intangible assets that have a specific useful life.

What is Straight Line Amortization?

Straight line amortization is a method for charging the cost of an intangible asset to expense at a consistent rate over time. This method is most commonly applied to intangible assets, since these assets are not usually consumed at an accelerated rate, as can be the case with some tangible assets. The formula for calculating the periodic charge under straight line amortization is:

(Book value of intangible asset - Expected salvage value) ÷ Number of periods

Straight line amortization is the same as straight line depreciation, except that it applies to intangible assets, rather than tangible assets.

Example of Straight Line Amortization

A business has bought a patent for $10,000 and expects to sell it off to another business in four years for $2,000. The calculation of its straight line amortization charge is:

($10,000 Patent book value - $2,000 Expected salvage value) ÷ 4 years

= $2,000 Amortization per year

If the business later finds that the remaining value of this patent has become impaired (perhaps because it is no longer being used), then the business can write off the remaining balance. This will terminate the recognition of any remaining amortization, since the asset will no longer have a net book value.

Straight-Line Amortization of a Loan

The straight-line amortization concept can also be applied to the repayment of a loan via a series of periodic payments that are in the same amount. Each of these payments includes an interest and principal component. Early in the series of payments, the bulk of the payments are comprised of interest charges, with modest principal repayments. As the principal repayments gradually reduce the outstanding amount of the loan, the proportion of interest expense in each successive payment declines, allowing for an increased proportion of each payment to be assigned to principal.