What is Amortization?

The word amortization has two common meanings in small business finance.

1. Amortizing intangible assets

For intangible assets such as purchased goodwill, customer lists, franchise rights or certain startup and organizational costs, amortization is the equivalent of depreciation: the cost is expensed gradually over a set period instead of all at once. For tax purposes, many acquired intangibles, known as section 197 intangibles, are amortized over 15 years. The IRS covers amortization in the instructions for Form 4562. Startup costs have their own rules; see tracking startup costs.

2. Amortizing a loan

For a loan, an amortization schedule shows how each payment is split between interest and principal over the loan's life. Early payments are mostly interest; later payments are mostly principal. The schedule is what you use to record each payment correctly, with interest as an expense and principal as a reduction of the liability. See recording loan payments.

Why it matters

Getting amortization wrong distorts profit: expensing an entire intangible purchase overstates expenses in year one, and recording loan payments entirely as expense overstates them every month.

Compare with accumulated depreciation, which applies to tangible assets.

Related terms

• Assets: Assets are resources a business owns or controls that are expected to provide future economic benefit.
• Accumulated Depreciation: Accumulated depreciation is the total depreciation recorded on an asset since it was placed in service.
• Depreciation: Depreciation spreads the cost of a long-lived business asset over the years it is used, rather than deducting it all at once.

Browse more definitions in the small business glossary.