Amortisation
Amortisation has two distinct meanings:
- It is the practice of reducing the value of assets to properly reflect their value over time.
- It can mean the servicing of debt in regular increments.
Reducing the value of assets to properly reflect their value over time
Amortisation is a balance sheet process where the value of an asset is reduced over a certain period of time, depending on the relevant accounting standards. Amortisation is essentially the same as depreciation, though it has a slightly different meaning.
In accounting, amortisation typically refers to systematically expensing finite-lived intangible assets (e.g., patents, customer lists, software, certain trademarks) over their useful lives. Goodwill and indefinite-lived intangibles are generally not amortised under IFRS and (for most entities) US GAAP; they are tested for impairment instead.
Depreciation is more generally used to describe the diminished value of fixed capital.
Servicing of debt in regular increments
Amortisation can also mean the periodic payment of principal and interest payments as it pertains to debt.
For example, a $12,000 loan repaid over 24 months will have an amortisation schedule that shows how each payment is split between interest and principal (at 0% interest, the payment would be $500/month; with interest, it would be higher).
Example of Balance Sheet Amortisation
Suppose a company has a finite-lived intangible asset (e.g., a patent) recorded at $10 million with a remaining useful life that implies $3 million of amortisation. The company would recognise $3 million of amortisation expense and reduce the asset’s carrying amount accordingly.
This would affect the three financial statements by reducing goodwill (an asset on the balance sheet) by $3 million. This would, in turn, reduce earnings on the income statement by $3 million.
Amortisation (and many impairment charges) is non-cash, so it is commonly added back in the operating section of the cash flow statement. While the accounting charge doesn’t directly use cash, cash flow can still be affected indirectly, most commonly through taxes (depending on the tax rules and deductibility).
To balance the balance sheet, the $3 million reduction in earnings would plug into retained earnings and result in a $3 million deduction in that account.
Amortisation’s Relevance to Day Trading
A reduction in a company’s asset base is a net negative (and vice versa, with an increase in a company’s asset base being a net positive). So if a company is writing off assets, this could be a bearish event for a company’s stock in relation to the extent of the write-off.
This is not something that those who exclusively focus on technical analysis would ever concern themselves with. However, it could be relevant to those who perform deep-dive fundamental analysis and really dig into a company’s balance sheet to compare assets versus their intrinsic value. Viable long/short theses on certain securities can thereby be formed if asset values are different relative to what the market is pricing in.