Amortization Meaning

What is Amortization:

The term amortization refers to the decrease of a credit or debt. In this case, it is the name of each payment made in order to settle the existing commitment. It is also known as financial amortization.

On the other hand, amortization is understood as the loss of value of an asset over time. This decrease must be periodically recorded in the accounting of the company during the useful life of said asset.

In this case, "depreciation" would be the most appropriate term to express the progressive decrease in the value of a company's assets, however, in many countries accounting regulations use the term amortization or technical amortization.

The word amortization comes from the Latin admortizare, which refers to the cancellation of a debt.

Financial amortization

This term can only be used if debt payments help lower principal. To calculate the amount of depreciation, you can use any of the following methods.

  • American system: throughout the loan period only interest is paid. Debt repayment is done when the period ends.
  • German system: repayments with fixed installments, but interest is paid in advance on each annuity.
  • French system: consists of repayments with fixed installments of capital and interest.

Technical amortization

The assets of a company can lose value for multiple reasons ranging from the end of their useful or technical life, their obsolescence (the assets still work, but are inefficient in the face of new technological developments), inflation, etc.

A technical amortization calculates the value of that depreciation, which allows the company to take accounting and economic measures to assume the restitution of those assets at the appropriate time.

To do this, a sinking fund is created, which are endowments of money that the company makes periodically, to guarantee financial resources available at the time an asset reaches its useful life. In this way it can be replaced quickly.

The amount or quantity of money allocated to the sinking fund depends on each company, but to calculate it, the annual depreciation of the assets to be replaced, their estimated useful life, and whether the fund is going to cover the original cost or if you are going to consider the replacement cost, among other criteria.

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