How to Calculate Amortization Expense for Tax Deductions

April 3, 2025 by Tasfir

High debt levels, poor cash flow, or unsustainable growth can still jeopardize long-term stability, despite a high EBITDA. By tracking EBITDA over time, business owners can evaluate their company’s performance and profitability trends. This helps identify growth patterns, seasonal fluctuations, and areas needing improvement.

However, most intangible assets have a clear and predetermined life span, like with a term insurance policy or a multiyear building lease. Once you know the numbers, take the asset cost and divide it by its useful life in years. The resulting number is your annual amortization expense, and you can deduct this total as an expense every year until the asset’s value goes to zero. Typically, businesses use the straight line method to allocate the cost of an intangible asset evenly over its expected useful life. For example, a $10,000 patent with a 10-year useful life would be amortized at $1,000 per year ($10,000 /10). Unlike loan amortizations, no principal or interest is involved, making the calculation more straightforward.

Depreciation can help businesses manage costs and plan for future expenses. It allows them to record asset value loss in a structured way and this could improve financial planning. Amortization is important because it helps businesses recognize expenses in the appropriate accounting period. This has a myriad of benefits, including relevant financial reports that help investors, owners and other stakeholders make effective economic decisions. Long-term assets are listed on the balance sheet, which provides a snapshot in time of the company’s assets, liabilities, and shareholder equity.

Depreciation accounts for the decrease in value of your tangible assets over time. Think about your dental equipment or office space — they wear down with daily use, and depreciation helps assign a monetary value to that wear and tear. This means that instead of taking on a large expense all at once, the cost is spread out over the useful life of the asset, reflecting its gradual loss in value. For financial reporting, book amortization and depreciation are calculated to reflect an accurate representation of a company’s asset values and profitability. These calculations comply with generally accepted accounting principles (GAAP) in the U.S., or international financial reporting standards (IFRS) internationally.

What’s the Difference Between Amortization and Depreciation in Accounting?

Depreciation focuses on tangible assets like equipment and buildings. Each process allows businesses to report expenses with more accuracy in their financial statements, impacting tax deductions and overall profitability. In much the same way that they depreciate physical property, companies use amortization to spread out the cost of an intangible asset that has a fixed useful life over the asset’s life. This method of recovering company capital is quite similar to the straight-line method of depreciation seen with physical assets. Your last loan payment will pay off the final amount remaining on your debt. For example, after exactly 30 years (or 360 monthly payments) you’ll pay off a 30-year mortgage.

If the asset has no residual value, simply divide the initial value by the lifespan. With the above information, use the amortization expense formula to find the journal entry amount. Residual value is the amount the asset will be worth after you’re done using it. EBITDA trends can inform expansion plans and major financial decisions.

The cost of acquiring the patent, say another $20,000 for legal fees, is also factored in, bringing the total to $200,000. This cost is then amortized over the life of the patent, leading to an annual amortization expense of $10,000. Hence, the company would report this amount as an expense on its income statement every year, reducing both its taxable income and the reported net income. Amortization is the process of spreading out a loan (such as a home loan or auto loans) into a series of fixed payments.

Amortization Schedule Table:

Many intangibles are amortized under Section 197 of the Internal Revenue Code. This means, for tax purposes, companies need to apply a 15-year useful life when calculating amortization for “section 197 intangibles,” according the to the IRS. During the loan period, only a small portion of the principal sum is amortized. So, at the end of the loan period, the final, huge balloon payment is made. This linear method allocates the total cost amount as the same each year until the asset’s useful life is exhausted. It is the concept of incrementally charging the cost (i.e., the expenditure required to acquire the asset) of an asset to expense over the asset’s useful life.

Impact of amortization on valuation and profitability

Making extra payments toward the principal can significantly reduce the total interest paid and shorten the loan term. The amortization schedule highlights how additional contributions affect the remaining balance and overall cost. Borrowers can plan early repayment strategies, ensuring their extra payments are applied correctly. Amortization in accounting is a technique that is used to gradually write-down the cost of an intangible asset over its expected period of use or, in other words, useful life. This shifts the asset to the income statement from the balance sheet. Most people use “amortization schedule” in the context of loans, where it outlines how a loan is paid down over time.

Internal control over amortization expense is important for all stakeholders in a business. For how to calculate amortization expense example, cash can be taken from a bank account and a false prepaid asset can be created, to conceal the theft. It helps them visualize their home equity growth and assess refinancing opportunities for better loan terms. Understanding how amortization is essential in managing loans and intangible assets. In this blog, we are going to understand what an amortization schedule is, types of amortization and a step-by-step method for calculating amortization for loans and intangible assets. On the balance sheet, as a contra account, will be the accumulated amortization account.

Initially, a more significant portion of each payment covers the interest, while gradually, more is applied toward reducing the principal. Amortization, derived from the Latin word meaning “to die off,” signifies the gradual elimination of a financial obligation. This process aids borrowers in financial planning and supports lenders in tracking payment progression. If a company’s operating cycle is longer than one year, the length of the operating cycle is used in place of the one-year time period. The accounting for amortization expense is a debit to the amortization expense account and a credit to the accumulated amortization account. The accumulated amortization account appears on the balance sheet as a contra account, and is paired with and positioned after the intangible assets line item.

How Does Amortization Affect a Company’s Financial Health?

By knowing how these concepts work, you can better plan for the future, whether it’s budgeting for new equipment or preparing for tax season. If you’re looking for more specific advice on how depreciation and amortization affect your practice, be sure to consult with your CPA. And if you have questions about managing your practice’s finances, Commerce Bank opens in a new window is here to help. Next, on the income statement — also known as a profit & loss statement — depreciation and amortization show up as expenses.

Calculating Amortization Expense

Just like with depreciation calculations, you can spread out the cost of an asset over its useful life. Amortization, in other words, is the practice of spreading the cost of intangible assets or a loan over a fixed time period. This systematic reduction in the value of an asset over time helps recognize the expense in a structured manner. For loans, it involves paying off the principal and interest through regular installments, while for intangible assets, it entails gradually expensing the asset’s cost over its useful life. Both amortization and depreciation affect a company’s financial statements by reducing taxable income.

Just like with depreciation calculations, you can spread out the cost of an asset over its useful life.
By leveraging Thomson Reuters Fixed Assets CS®, firms can effectively manage assets with unlimited depreciation treatments, customized reporting, and more.
Next, subtract the first month’s interest from the monthly payment to find the principal payment amount.

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How to Calculate Amortization for an Intangible Asset

An amortization schedule details each payment period, including the exact amount that goes to interest and the principal. This provides clarity to businesses in terms of how their money is applied to loan balance and interest,facilitating better financial planning and gauging the long-term borrowing cost. Besides considering the monthly payment, you should consider the term of the loan (the number of years required to pay it off if you make regular payments).

Alex will repeat this process for each month, updating the interest, principal payment, and remaining balance until the loan is fully paid off.
When you record amortization on financial statements, you’re essentially capturing how much of an intangible asset’s value has been used up during the period.
The principal is the original loan amount, or the balance that you must pay off.
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These expenses reduce your net income, which in turn can lead to lower income taxes.
As a result, certain expenses are amortized over a specified amount of time, so expenses are recognized in the appropriate accounting periods.

Recording these payments periodically reduces the book value of a loan or an intangible asset over the specified duration. Calculating amortization helps determine how to repay your debt over a given time period. Record amortization expenses on the income statement under a line item called “depreciation and amortization.” Debit the amortization expense to increase the asset account and reduce revenue. Finally, add back depreciation and amortization, both of which are non-cash expenses.

Tangible assets like machinery are depreciated, while intangible assets like patents are amortized. Then, assess the asset’s useful life; if it’s finite, it’s likely to be amortized. Always adhere to relevant accounting and tax regulations for proper categorization. First, on the balance sheet, depreciation and amortization lower the value of assets over time.