What is Amortization? Complete Definition, Examples & Formulas

Amortization is an important component in finance. Understand the meaning of amortization, functions, examples and amortization formulas, including the following debt amortization.

Have you ever heard the term amortization in financial reports, but are still confused about what it means? Don’t worry, you are not alone. Many people think that amortization is the same as depreciation. In fact, both have different concepts and applications. Come on, let’s discuss in more depth what amortization is, complete with definitions, examples, functions, and amortization formulas that are easy to understand, even for those of you who are just starting to learn finance.

Also read: Depreciation: Types, Methods and Examples in Accounting

Understanding Amortization: Not Just an Accounting Term

In simple terms, amortization is the process of allocating the cost of an intangible asset over its useful life. This means that if you have assets that cannot be touched (such as copyrights, licenses, trademarks, or software), their value will be recorded and “reduced” little by little every year.

In other words, amortization helps show that the value of the asset decreases over time as it is used to generate income. This is important so that your financial reports reflect actual conditions, not artificial figures that are too high.

For example, if a company buys a software license for IDR 120 million with a useful life of 5 years, then every year the company will record amortization costs of IDR 24 million. In this way, the burden can be adjusted proportionally and not be burdensome in just one period.

So, it can be concluded that amortization is a method for dividing the value of intangible assets into several periods, according to their economic life.

Types of Amortization and Their Functions in Finance

Amortization isn’t just a complicated accounting term. Amortization has a practical and important function, both for businesses and individuals. The following are several types and functions of amortization:

1. Amortization of Intangible Assets

This type is used to allocate the value of non-physical assets, such as patents, licenses, trademarks, goodwill, or software. For example, an example of amortization is recording software license costs over their lifetime so that financial reports remain accurate.

2. Debt Amortization

Different from assets, debt amortization is the process of gradually paying off a loan through installments consisting of principal and interest.

Every payment you make to the bank is actually divided into two: partly to reduce the principal, and partly to pay interest. Over time, the proportion of principal payments gets bigger and the interest gets smaller.

Debt amortization is generally used to:

• Home credit (KPR)
• Motor vehicle loans
• Unsecured credit (KTA)
• Business loans or business capital

By understanding debt amortization, you can know how quickly your loan is reducing and how much total interest you are actually paying.

Also read: What is Equity? This is its meaning, components and function in business

Important Functions of Amortization

Why is amortization important? Here are some reasons:

1. Shows realistic asset values
   Intangible assets such as copyrights or licenses have a limited useful life. With amortization, the value can be adjusted according to its use over time.
2. Manage tax burden and net profit
   Because amortization costs are non-cash expenses, companies can deduct them from taxable profits, making the tax burden more efficient.
3. Help with cash flow planning
   By knowing the amount of debt amortization, you can plan your monthly expenses more accurately and avoid the risk of default.
4. Increase financial transparency
   Investors or banks can see the company’s financial condition more clearly because amortization reflects the value of assets and debts more accurately.

Easy to Understand Amortization Example

To better understand, here are some an example of amortization is:

1. Amortization of Patent Rights

A pharmaceutical company buys a drug patent for IDR 500 million and a useful life of 10 years. Every year, the company records amortization costs of IDR 50 million.

This means that the value of the patent on the balance sheet will decrease gradually every year until its useful life finally expires.

2. Software Amortization

The company purchased internal accounting software worth IDR 120 million with a service life of 5 years. Every year an amortization fee of IDR 24 million will be recorded so that the financial statements remain in line with their real value.

3. Debt Amortization (KPR)

You take out a home loan of IDR 600 million with 10% interest per year for 15 years.
Every month you pay fixed installments of around IDR 6.5 million. In the beginning, most of the payments go to interest, but over time the proportion of principal increases. In this case, debt amortization is a loan repayment process that is structured so that the payment burden feels lighter and more planned.

Also read: Understanding the Difference Between Debts and Receivables

Amortization Formula

1. Intangible Asset Amortization Formula

The simple formula:

Annual Amortization = (Initial Value of Asset – Residual Value) / Useful Life

Example:

• Copyright Value: Rp. 100,000,000
• Residual value: IDR 0
• Useful life: 5 years
  

For: Annual Amortization = (100,000,000 – 0) / 5 = IDR 20,000,000 per year

So, you record the amortization costs are IDR 20 million every year for 5 years.

2. Debt Amortization Formula

If you want to calculate the monthly installments on a loan (such as a mortgage or vehicle loan), you can use the following debt amortization formula in Excel:

=PMT(interest_per_year/amount_of_period_per_year; total_period; -loan_amount)

Example:

• Loan amount: IDR 100,000,000
• Interest: 12% per year
• Term: 5 years (60 months)

The formula:
=PMT(12%/12; 60; -100000000)

The results will show a fixed monthly installment amount including principal and interest. From there, you can see how debt amortization works every month, where the principal proportion gets bigger as time goes by.

Amortization’s Relationship to Financial Health

It turns out that amortization is not just a matter for accountants or large companies. For individuals like you who have installments or assets, understanding amortization can help maintain personal financial health. By knowing how much your assets are actually worth and how quickly your debts are decreasing, you can plan your financial steps more wisely.

For example:

• Determine when is the ideal time to pay off the loan more quickly
• Calculate profits or losses if you refinance
• Prepare a monthly budget without worrying about being overpaid by installments

In other words, amortization is an important tool for those of you who want to build long-term financial stability.

Also read: What is the Grace Period? Definition and Examples

Check and Manage Your Credit More Easily with Skorlife

If you have installments or are planning to apply for new credit, whether it’s a mortgage, vehicle or KTA, it’s important to know your financial position before applying. You can check your financial condition via score lifeapplication to help you understand more about personal financial health.

In the app score lifeyou can:

• Check Credit History directly from official institutions (not estimates, but actual data).
• See Opportunities for Approved Credit Applicationsso you can be more confident before applying for a loan.
• Organize and Manage Finances through the arrears payment recommendation feature to easy-to-use budgeting.

That way, you can manage debt amortization and installments with a smarter strategy, not only paying regularly, but also understanding the impact on cash flow as well credit score-in the.

Conclusion

In short, amortization is a way of allocating the cost of intangible assets or gradual repayment of debt. Amortization costs are the recording of annual expenses to reflect the decline in asset value, while examples of amortization are patents, licenses, software, or mortgage payments. Meanwhile, debt amortization is a method of paying off loans in fixed installments, and the amortization formula helps calculate the exact value of the burden or installments. By understanding this concept, you can read financial reports smarter, manage loans more efficiently, and keep cash flow healthy.

FAQ Regarding Amortization

1. What is meant by amortization?

Amortization is the process of gradually dividing the cost of an intangible asset or paying off debt over its useful life. The aim is to ensure that asset values ​​or loan expenses are recorded realistically in financial reports.

2. What is the difference between depreciation and amortization?

Depreciation is used for tangible assets such as machines, vehicles, or buildings, while amortization applies to intangible assets such as patents, licenses, software, or goodwill.

3. How do you calculate amortization?

For intangible assets, the formula is simple: Annual Amortization = (Asset Value – Residual Value) / Useful Life

For debt, you can use the Excel formula: =PMT(interest/year; period_amount; -loan_amount).

This formula will show a fixed installment amount that includes principal and interest.

4. What are examples of amortization?

Some examples of amortization are patent rights, software licenses, trademarks, or mortgage installments to vehicle loans. In essence, this is the allocation of costs or payments in stages.

5. Why is amortization important?

Amortization helps realistically assess asset values, plan cash flow, manage tax burdens, and make financial reports more transparent. For individuals, this is useful for keeping debt repayments and personal finances under control.