What is amortization?

Published Monday 22 June 2026

Table of contents

• What is amortization
• Asset amortization vs loan amortization
• Why amortization matters
• How amortization works
• How to calculate amortization
• 4 common methods of amortization
• Amortization for tax purposes
• Amortization schedules
• Amortization vs depreciation
• Is goodwill amortized?
• Simplify your amortization tracking with Xero
• FAQs on amortization

Key takeaways

• Amortization spreads the cost of an intangible asset across its useful life, giving you a more accurate picture of your profit and loss each year.
• Loan amortization is different from asset amortization; it refers to paying down a debt through scheduled payments of principal and interest over time.
• The IRS allows you to amortize certain intangible assets over 15 years under Section 197, which can reduce your taxable income.
• Understanding amortization methods and schedules helps you plan cash flow, stay compliant with tax rules, and make better financial decisions for your business.

What is amortization

Amortization is the process of spreading the cost of an intangible asset over its useful life. It can also refer to paying down a loan through regular scheduled payments.

In accounting, amortization applies to intangible assets like patents, trademarks, copyrights, and software licenses. Instead of recording the full purchase price as a single expense, you write off a portion of the cost in each accounting period. This follows the matching principle under generally accepted accounting principles (GAAP), which requires expenses to be recognized in the same period as the revenue they help generate.

Asset amortization vs loan amortization

The term "amortization" has 2 distinct meanings in finance, and it's worth understanding both before diving deeper.

Asset amortization is an accounting method. When your business buys an intangible asset, you record a portion of its cost as an expense each year over its useful life. This gradually reduces the asset's value on your balance sheet.

Loan amortization is a repayment method. Each payment you make on an amortizing loan covers both principal and interest. Early payments go mostly toward interest, while later payments go mostly toward principal. Mortgages, car loans, and personal loans typically follow this structure.

Not all loans are amortizing. Interest-only loans and balloon payment loans don't reduce the principal with each payment. This article focuses primarily on asset amortization, though the calculation section covers loan amortization as well.

Why amortization matters

Amortization gives you a more accurate view of your business's profitability over time.

Without amortization, the full cost of an intangible asset would hit your books in a single year. That would make your profits look artificially low in the year of purchase and artificially high in every year after.

For example, say your business buys a 20-year patent for $100,000. Writing off the entire amount in year 1 would reduce that year's profit by $100,000. But you'll benefit from the patent for 20 years. Amortizing $5,000 per year distributes the cost more evenly, so your income statement reflects the true cost of doing business each year.

For small business owners, this matters for tax planning, cash flow forecasting, and understanding your real profit margins. It also helps you make informed decisions about when to invest in new intangible assets.

How amortization works

Amortization works by spreading the cost of an intangible asset across the accounting periods that benefit from it.

When you purchase an intangible asset, you record its full value on your balance sheet. At the end of each accounting period, you record an amortization expense to reflect the portion of the asset's value used during that period. This reduces the asset's carrying value on the balance sheet over time.

The journal entry for amortization involves 2 accounts. You debit "amortization expense" on the income statement and credit "accumulated amortization" on the balance sheet. This expense reduces your taxable income for that period.

The process continues each year until the asset is fully amortized, meaning its carrying value reaches zero or its residual value. For a patent, this would continue until the patent expires or has no remaining value.

How to calculate amortization

Calculating amortization starts with knowing the asset's cost, its useful life, and which method you're using.

The most common approach is straight-line amortization. The formula is:

Annual amortization = capitalized cost / estimated useful life

Here's a worked example. Your business acquires a software license for $60,000 with a useful life of 5 years. Using straight-line amortization:

$60,000 / 5 years = $12,000 per year

You'd record $12,000 as an amortization expense each year for 5 years. The calculation depends on 3 factors:

• The capitalized cost of the asset (the purchase price plus any costs to get it ready for use)
• The asset's estimated useful life (which the Internal Revenue Service (IRS) may define for tax purposes)
• The amortization method you're using (which is also subject to IRS rules)

Accounting software can automate these calculations, but the inputs must be accurate and compliant. Consult with an accountant or bookkeeper to avoid costly mistakes. You can find one in the Xero advisor directory.

4 common methods of amortization

There are several ways to calculate amortization, and the IRS sets rules about which methods can be used in specific situations. Always consult with an expert before choosing a method.

1. Straight-line amortization

An equal portion of the asset's value is amortized each year of its useful life. For example, a $150,000 asset with a 15-year lifespan would be amortized at $10,000 per year. This is the most commonly used method and the simplest to calculate.

2. Declining balance method

The asset is amortized more heavily in its early years and by smaller amounts in later years. If an asset costs $10,000 and you amortize at 30% per year, you'd record $3,000 in year 1. In year 2, the remaining value is $7,000, so 30% amortization would be $2,100. This pattern continues until the asset is fully amortized.

3. Double declining balance method

This is a variation of the declining balance approach where the rate is set by dividing 2 by the asset's useful life. An asset with a 5-year life would be amortized at 40% per year (2 / 5 x 100 = 40%). This front-loads the expense even more aggressively than the standard declining balance method.

4. Annuity method

The asset is amortized based on how much revenue it generates each year. This requires a model for estimating the asset's lifetime income. It's the most complex method and is less commonly used for small business accounting.

Amortization for tax purposes

Tax amortization follows specific IRS rules that may differ from how you record amortization on your financial statements.

Under IRS Section 197, certain intangible assets acquired as part of a business purchase must be amortized over 15 years. These include goodwill, customer lists, patents, trademarks, franchises, and non-compete agreements. You report this amortization on IRS Form 4562.

Not all intangible assets fall under Section 197. Self-created intangibles, interests in land, and certain financial instruments have different rules. The IRS generally requires straight-line amortization for Section 197 assets, regardless of the method you use for your financial books.

Keep in mind that your book amortization (for financial reporting) and tax amortization (for your tax return) can differ. Your financial statements might use a 10-year life for an asset, while the IRS requires 15 years. This creates a temporary difference that you'll need to track. Working with a tax professional helps you stay compliant and get the deductions you're entitled to.

Amortization schedules

An amortization schedule is a detailed breakdown showing how an asset's cost is allocated across each period of its useful life.

For asset amortization, the schedule typically shows the beginning balance, the amortization expense for that period, and the remaining book value. Here's how a straight-line schedule might look for a $50,000 trademark with a 5-year useful life:

• Year 1: $10,000 expense, $40,000 remaining value
• Year 2: $10,000 expense, $30,000 remaining value
• Year 3: $10,000 expense, $20,000 remaining value
• Year 4: $10,000 expense, $10,000 remaining value
• Year 5: $10,000 expense, $0 remaining value

For loan amortization, the schedule shows each payment broken into principal and interest, along with the remaining loan balance. This helps you see exactly how much of each payment reduces your debt versus how much goes to interest.

Accounting software can generate these schedules automatically, saving you time and reducing errors. Having a clear schedule also makes tax preparation easier, since you'll have a ready reference for the amortization expense to report each year.

Amortization vs depreciation

Amortization and depreciation both spread an asset's cost over time, but they apply to different types of assets.

Here are the key differences:

• Amortization applies to intangible assets (patents, copyrights, licenses, software). Depreciation applies to tangible assets (vehicles, equipment, machinery, buildings).
• Intangible assets typically have no salvage value, so the full cost is amortized. Tangible assets often have a residual or salvage value that's subtracted before calculating depreciation.
• Amortization most commonly uses the straight-line method. Depreciation offers more method options, including units of production and sum-of-the-years-digits.
• Both are non-cash expenses that reduce taxable income without affecting your actual cash flow. You can learn more about how depreciation works in detail.

You'll sometimes see both amortization and depreciation referenced in the context of EBITDA (earnings before interest, taxes, depreciation, and amortization). EBITDA is a common measure of operating performance that strips out these non-cash charges, giving you a clearer view of your business's core profitability.

Is goodwill amortized?

The answer depends on whether you're looking at financial reporting or tax reporting.

Under GAAP, goodwill is not amortized. Instead, it stays on your balance sheet and is tested for impairment at least once a year. If the value of the acquired business drops below what you paid, you record an impairment loss. There is a private company exception that allows smaller businesses to elect to amortize goodwill over 10 years using the straight-line method.

For tax purposes, the IRS treats goodwill differently. Under Section 197, goodwill acquired as part of a business purchase is amortized over 15 years using the straight-line method. This means you can deduct a portion of the goodwill cost each year on your tax return, even if you're not amortizing it on your financial statements.

If your business has acquired another company, it's worth discussing goodwill treatment with your accountant to make sure your books and tax returns are both handled correctly.

Simplify your amortization tracking with Xero

Tracking amortization doesn't have to be complicated. Xero Accounting Software gives you customizable reporting and automated record-keeping, so you can stay on top of your intangible asset expenses with less manual work. Get one month free.

FAQs on amortization

Here are some frequently asked questions about amortization.

Is amortization an expense or a liability?

Amortization is an expense. It appears on your income statement as "amortization expense," reducing your net income for the period. The related balance sheet entry, "accumulated amortization," is a contra-asset account that reduces the asset's carrying value.

How many years can you amortize an intangible asset?

The useful life depends on the type of asset and the applicable rules. For tax purposes, IRS Section 197 intangibles are amortized over 15 years, while other intangibles follow the asset's actual useful life or the terms of the agreement that created them.

Can you amortize startup costs?

Yes, the IRS allows you to deduct up to $5,000 in startup costs in your first year of business, with the remainder amortized over 180 months (15 years). If your total startup costs exceed $50,000, the $5,000 deduction begins to phase out.

What happens when an intangible asset is fully amortized?

Once fully amortized, the asset's book value is zero and you stop recording amortization expense. If the asset still has value to your business (for example, a trademark you continue using), it remains on your balance sheet at zero value until you dispose of it.

Do all intangible assets get amortized?

No. Intangible assets with indefinite useful lives, such as certain trademarks and goodwill under GAAP, are not amortized. Instead, they're tested for impairment annually. Only intangible assets with finite useful lives are amortized over those lives.