What is Amortisation – Complete Guide to Meaning, Types & Examples

Amortisation is an accounting method that spreads the cost of a loan or an intangible asset over time. It helps reduce the value of the loan or asset step by step during its useful life.

Let’s understand this with a loan example. Suppose Riya borrows ₹1,20,000 from a bank at 10% annual interest for 3 years. She repays it in equal yearly instalments. Each year, a portion of the payment goes toward interest, and the remainder reduces the loan amount.
 

Over time, the loan balance reduces to zero. The same idea applies to intangible assets, such as patents, where the value is gradually depreciated in the books each year.

How Amortisation Works in Everyday Life?

Amortisation means two main things in accounting:

1. Paying Off a Loan Step by Step

When you take out a loan, such as for a house or car, you repay it in installments. Each payment covers:

• Some interest (the extra fee for borrowing), and
• Some principal (the amount you borrowed).

This steady repayment plan is called amortisation. It continues until the whole loan is paid off.

2. Spreading the Cost of Things You Can’t Touch

Businesses often buy things like licences or software. These are called intangible assets. They don’t wear out like machines, but they still lose value over time. Instead of showing the full cost at once, companies divide the cost across the asset’s useful life. This is also amortisation.

So, amortisation helps both people and companies handle money slowly and smartly over time.

Why Amortisation Matters?

Amortisation is important because it helps people and businesses understand where their money goes.

1. For Loans – Know What You’re Paying For

Let’s say Ravi takes a loan to buy a scooter. Every month, he pays ₹5,000. But is it all going to the loan amount? No!
Some of it pays the interest (extra charge for borrowing), and the rest pays the loan itself.

Amortisation breaks this down clearly so Ravi knows exactly how much of his money is going where.

2. For Businesses – Smarter Tax and Cost Planning

Now imagine a company buys software for ₹1,00,000 to use for 5 years. Instead of showing the full cost in year one, it spreads it over 5 years ₹20,000 each year.
This is amortisation too. It helps the business:

• Lower its tax each year, and
• Show clearer profits to investors.

So whether it’s a scooter loan or a software cost, amortisation helps you plan better, save tax, and stay in control.

Paying Back a Loan Through Amortisation

Amortisation of a loan means slowly paying back the full amount you owe. When you take a loan, the bank sets up a fixed monthly payment. This amount stays the same each month, but how it’s used changes over time.

Each payment includes:

• Interest – the bank’s charge for lending you money.
• Principal – the actual amount you borrowed.

Let’s say Meena borrows ₹60,000 for 3 years at 10% interest. She agrees to pay ₹24,100 every year.
 

By the end of Year 3, Meena has fully repaid the loan. That’s how loan amortisation works clear, steady, and planned.

How does Amortisation work for Assets You Can’t Touch?

Amortisation isn’t just for loans. It also helps when businesses buy intangible assets, things you can’t see or touch, like:

• A brand name
• A patent
• A trademark
• Software

These things lose value slowly, just like a car or machine. This slow drop in value is called amortisation.

Let’s take an example. A company buys software for ₹1,00,000, and they plan to use it for 5 years. Instead of showing the full ₹1,00,000 cost in one year, they spread it evenly across 5 years.
 

So after 5 years, the value of the software becomes zero in the company’s books. That’s amortisation of an asset, fair, clear, and simple!

Difference Between Amortisation and Depreciation

Amortisation and depreciation both reduce the value of assets over time, but they apply to different types of assets and work in slightly different ways. Here's a simple comparison:

Example for Amortisation:

A company buys a software licence for ₹1,00,000 to use for 5 years. It reduces the value by ₹20,000 every year.

Example for Depreciation:

A bakery buys an oven for ₹1,00,000. It reduces its value by ₹25,000 each year for 4 years as it wears out.

So, while both methods help track asset value and cost over time, amortisation is used for non-physical items, and depreciation is used for physical ones.

Conclusion

Amortisation helps people and businesses spread the cost of loans or intangible assets over time. It breaks big payments or values into smaller, manageable parts. Whether you repay a loan or reduce an asset’s value, amortisation keeps money matters organised, clear, and easy to track.

FAQ’s

1. Why do we use amortisation?
We use amortisation to spread the cost of loans or intangible assets over time. It helps manage finances better and gives a clear view of payments or asset value each year.

2. Is amortisation the same as depreciation?
No. Amortisation is used for intangible assets, while depreciation is for physical ones like machines or vehicles. Both reduce value over time.

3. Can amortisation reduce tax?
Yes. Spreading the cost of assets over time reduces yearly profits, which can lower the amount of tax a business has to pay.

4. Does the loan payment stay the same in amortisation?
Yes. In most loans, the payment amount stays the same, but the portion that goes to interest and principal changes each time.

5. Can individuals use amortisation?
Yes. Anyone with a loan, like a home loan or car loan, uses amortisation without realising it, through monthly fixed repayments.
 

Apply for Loans Fast and Hassle-Free

Apply Now

About the Author

LoansJagat Team

‘Simplify Finance for Everyone.’ This is the common goal of our team, as we try to explain any topic with relatable examples. From personal to business finance, managing EMIs to becoming debt-free, we do extensive research on each and every parameter, so you don’t have to. Scroll up and have a look at what 15+ years of experience in the BFSI sector looks like.