Discussion
The remaining principal in the column after payment #1 and payment # 2 would be $ 47,500. The accounting term amortization refers to the method of distributing the cost of intangible assets over a time period (Ross, 2015). It also refers to the method by which the principal component of a loan is repaid over years. Even as the number of years over which certain intangible assets are amortized varies, assets are amortized over their useful life. In case of loans or bonds, the amortization period is usually the loan period or the maturity time.
When I avail a personal home loan and repay in installments, a portion of each installment goes to the payment of interest and another portion goes to the payment of principal. A major portion of the repayment would go towards interest during the initial months. My amortization schedule would show the interest and principal components for each month and how the principal component decreases over years. The amortization schedule would motivate me to effect prompt repayment as I am attracted by seeing the principal decreasing over a period of time.
Assuming that a business concern possesses a patent for a new technology that lasts for 15 years and the company spends $ 30 million towards developing the technology, the company would record on the income statement as amortization expense $ 2 million over a period of 15 years.
Company ABC has $ 20 million as outstanding loan. If it repays $ 1 million each year, an amount of $ 1 million is said to be amortized each year. In other words, the entire loan amount is repaid in twenty equal installments. Knowing the installment amount for each year and the number of installment each year helps the company to do its financial planning well in advance.
Reference
Ross, S. (2015). What is the difference between amortization and depreciation? Retrieved from http://www.investopedia.com/ask/answers/06/amortizationvsdepreciation.asp
