Amortization Definition & How To Calculate It

For entrepreneurs who have been developing their business for a long time, maybe hearing the word amortization is a common thing. However, some of those who already have a business have never even heard of and understood what amortization is.

In the world of finance, amortization is often associated with those who want to apply for a business loan or those who want to pay debts, bills and the like.

This is indeed in accordance with the definition of amortization, namely amortization is the payment of debt which is carried out in stages over a certain period of time.

Explanation of Amortization

As we discussed a little above, amortization is a debt payment procedure that is carried out in stages over a certain period of time. For example, monthly payments for mortgage loans (House Ownership Credit), AOC (Apartment Ownership Credit), vehicle loans or credit card debt.

Amortization is often used in several fields such as finance, accounting and taxation. In order for amortization to run effectively, it is necessary that the amount of payments or the total installments must be large enough to pay the principal and interest.

Hence amortization also refers to the spread of the cost of capital for an intangible asset over a certain period of time. It can also be defined as an accounting procedure that can reduce the value of costs and intangible assets gradually.

Amortization can also be interpreted as a decrease in the depreciation value of an asset that has a long economic life.

Knowing the Definition of Amortization

Amortization is a way to pay off debt in a certain period of time gradually. Usually examples of this amortization are monthly bills such as vehicle loans, mortgage loans, credit card loans, and so on.

This amortization also has an effect on assets or tax amortization (fiscal amortization), where this calculation is carried out specifically when making the payment process.

Therefore these payments are referred to as installments or installments. So that the payment of the bill can be said to be greater than the loan principal and interest, which is charged to the borrower so that the debt will slowly be paid off.

Amortization Fund

Amortization fund is a fund collection that is conducted periodically to pay the amortization expense in each period. In fact, amortization has a purpose, one of which is a reflection of the resale value.

Example of Amortization

  • A company that has a loan of $. 10 million and each year is paid in installments of $. 75,000 per year, then the company is considered to have amortized the loan of $. 75,000 per year.
  • An automotive company that has a patent on the engine for 10 years. The company spent $ 25,000,000 for product development, it will be recognized and recorded at $ 2,500,000 per year for 10 years as amortization expense.

The above are some examples of amortization in a company or business that does amortization.

How to Calculate Amortization

The company should pay the debt for amortization which usually includes payment of principal and interest. This is so that the principal of the loan on the balance of the debt must be repaid by the company.

So when the more principal is paid, the interest will decrease. There are two ways to calculate amortization, namely:

1. How to Calculate Loan Amortization in the First Month

In calculating the principal for the first month of amortization, there are 6 steps that must be carried out, namely:

First, you need to collect data on amortization calculations where this step is obtained from data on interest rates, loan principals, and loan tenors.

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