amortization

A cost *allocation method used to record the reduction in value of an asset over time. The classic case of amortization is the matching of the cost of an item of *property, plant, and equipment to its *useful life. Assets generally lose value as a result of *wear and tear, damage, and *obsolescence, and *amortization methodology is based on the matching of an asset’s cost to the periods of time in which the asset generates economic benefits. The term *depreciation is often used when referring to *tangible assets, and the term amortization when referring to *intangible assets, but in practice the terms are often used synonymously. Amortization accounting can be on a *straight-line basis, with regular fixed expenses, or on a reducing balance or *accelerated method in which larger amortization charges occur in earlier time periods. Accelerated amortization is often justified on the grounds of an asset’s intensive use in the early years of its life - a *sum of the digits methodology is sometimes used for this purpose. There are also other, sophisticated amortization accounting methods that attempt to closely match an asset’s costs to fluctuations in economic value over its life. These include devaluations of an asset’s *historic cost. Amortization can be calculated on the full cost of an asset, but the costs of many assets are adjusted to reflect any resale or *residual value. To take a simple example, an asset that costs $100,000 with a useful life of 10 years, and no residual value, would be amortized at a rate of $10,000 a year on a straight-line basis. In many countries, amortization rates are fixed by legislation, but * Generally Accepted Accounting Principles in most English-speaking countries allow a corporation’s management to base amortization rates on reasonable estimates of assets’ useful lives.