amortization

57
• Amortization https://store.theartofservice.com/the-amortization- toolkit.html

Upload: barbra-preston

Post on 12-Jan-2016

236 views

Category:

Documents


0 download

TRANSCRIPT

Page 1: Amortization

• Amortization

https://store.theartofservice.com/the-amortization-toolkit.html

Page 2: Amortization

Amortization

1 'Amortization' (or 'amortisation') is the process of decreasing, or

accounting for, an amount over a period. The word comes from Middle English amortisen to kill, alienate in

mortmain, from Anglo-French amorteser, alteration of amortir, from

Vulgar Latin admortire to kill, from Latin ad- + mort-, mors death.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 3: Amortization

Amortization - Applications of amortization

1 Negative amortization is an amortization schedule where the loan

amount actually increases through not paying the full interest.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 4: Amortization

Amortization - Applications of amortization

1 *In business, amortization (business)|amortization allocates a lump sum amount to different time periods,

particularly for loans and other forms of finance, including related interest or

other finance charges. Amortization is also applied to capital expenditures of certain assets under accounting rules,

particularly intangible assets, in a manner analogous to depreciation.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 5: Amortization

Amortization - Applications of amortization

1 *In the context of zoning|zoning regulations, amortization refers to the time in which a property owner has to

conform or relocate when the property's use constitutes a preexisting

nonconforming use under amended zoning regulations. Specifically it is the ability of the owner of the property to recoup his/her investment during that

time.https://store.theartofservice.com/the-amortization-toolkit.html

Page 6: Amortization

Goodwill (accounting) - Amortization and adjustments to carrying value

1 Companies objected to the removal of the option to use pooling-of-interests, so amortization was

removed by Financial Accounting Standards Board as a concession

https://store.theartofservice.com/the-amortization-toolkit.html

Page 7: Amortization

Depreciation - Depletion and amortization

1 Depletion_(accounting) | Depletion and amortization are similar

concepts for minerals (including oil) and intangible assets, respectively.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 8: Amortization

Earnings before interest, taxes, depreciation and amortization

1 A company's 'Profit (accounting)|earnings before interest, taxes, depreciation, and

amortization (tax law)|amortization' (commonly abbreviated 'EBITDA',

pronounced ,Professional English in Use Finance, Cambridge University Press , or ) is

computed by considering a company's earnings before interest payments, tax,

depreciation, and amortization are subtracted for any final accounting of its

income and expenses

https://store.theartofservice.com/the-amortization-toolkit.html

Page 9: Amortization

Earnings before interest, taxes, depreciation and amortization

1 It is intended to allow a comparison of profitability between different companies,

by canceling the effects of interest payments from different forms of financing (by ignoring interest payments), political jurisdictions (by ignoring tax), collections

of assets (by ignoring depreciation of assets), and different takeover histories

(by ignoring amortization often stemming from goodwill (accounting)|goodwill).

https://store.theartofservice.com/the-amortization-toolkit.html

Page 10: Amortization

Earnings before interest, taxes, depreciation and amortization

1 Warren Buffett famously asked: Does management think the tooth fairy

pays for capital expenditures? Depreciation is often a very good

approximation of the capital expenditures required to maintain

the asset base, so it has been argued that EBITA (Earnings before Interest, Taxes and Amortization) would be a

better indicator.https://store.theartofservice.com/the-amortization-toolkit.html

Page 11: Amortization

Amortization (tax law)

1 In tax law, 'amortization' refers to the cost recovery system for intangible property.

Although the theory behind cost recovery deductions of amortization is to deduct from cost basis|basis in a systematic manner over an asset's estimated useful economic life so

as to reflect its consumption, expiration, obsolescence or other decline in value as a result of use or the passage of time, many

times a perfect match of income and deductions does not occur for policy reasons.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 12: Amortization

Amortization (tax law) - Depreciation

1 A corresponding concept for tangible assets is depreciation. Methodologies for allocating amortization to each tax period

are generally the same as for depreciation. However, many intangible assets such as

goodwill or certain brands may be deemed to have an indefinite useful life, or “self-created” and are therefore not subject to amortization.House Report No. 103-111,

103rd Congress, 25 May 1993.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 13: Amortization

Amortization (tax law) - Intangible property

1 Intangible property which is subject to amortization is described in 26 U.S.C

https://store.theartofservice.com/the-amortization-toolkit.html

Page 14: Amortization

Amortization (tax law) - Intangible property

1 Under §197 most acquired intangible assets are to be amortized ratably over a fifteen-

year period.House Report No. 103-111. This is not the best treatment of an intangible

whose actual life is much shorter than fifteen years. Furthermore, if an intangible is not eligible for amortization under § 197,

the taxpayer can depreciate the asset if there is a showing of the assets useful life.Treasury Regulation § 1.167(a)(3).

https://store.theartofservice.com/the-amortization-toolkit.html

Page 15: Amortization

Amortization (tax law) - Start-up expenditure

1 For amortization as it relates to start-up expenses for a new business or activity.26

U.S.C

https://store.theartofservice.com/the-amortization-toolkit.html

Page 16: Amortization

Earnings Before Interest, Taxes, Depreciation, Amortization, and Restructuring or Rent Costs

1 'Earnings before interest, taxes, depreciation, amortization, and rent (or restructuring) costs' (EBITDAR) is a non-Generally Accepted Accounting

Principles|GAAP metric that can be used to evaluate a company's

financial performance.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 17: Amortization

Earnings Before Interest, Taxes, Depreciation, Amortization, and Restructuring or Rent Costs

1 ::EBITDAR = revenue – expenses (excluding tax, interest, depreciation,

amortization and rent costs)

https://store.theartofservice.com/the-amortization-toolkit.html

Page 18: Amortization

Earnings before interest, taxes, depreciation, and amortization

1 A company's 'Profit (accounting)|earnings before interest, taxes, depreciation, and amortization (tax law)|amortization' (commonly abbreviated 'EBITDA',

pronounced ,Professional English in Use Finance, Cambridge University Press , or ) is an accounting

measure calculated using a company's net earnings, before interest expenses, taxes, depreciation and

amortization are subtracted, as a proxy for a company's current operating profitability, i.e., how much profit it makes with its present assets and its operations on the products it produces and sells, as

well as providing a proxy for cash flow.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 19: Amortization

Earnings before interest, taxes, depreciation, and amortization

1 It is intended to allow a comparison of profitability between different companies,

by discounting the effects of interest payments from different forms of financing (by ignoring interest payments), political jurisdictions (by ignoring tax), collections

of assets (by ignoring depreciation of assets), and different takeover histories

(by ignoring amortization often stemming from goodwill (accounting)|goodwill)

https://store.theartofservice.com/the-amortization-toolkit.html

Page 20: Amortization

Negative amortization

1 The term is most often used for mortgage loans; corporate loans with negative amortization are called PIK

loans.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 21: Amortization

Negative amortization

1 Amortization refers to the process of paying off a debt (often from a loan

or mortgage) over time through regular payments. A portion of each

payment is for interest while the remaining amount is applied towards

the principal balance. The percentage of interest versus principal in each payment is

determined in an amortization schedule.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 22: Amortization

Negative amortization - Defining characteristics

1 Negative amortization only occurs in loans in which the periodic payment

does not cover the amount of interest due for that loan period

https://store.theartofservice.com/the-amortization-toolkit.html

Page 23: Amortization

Negative amortization - Typical circumstances

1 Start rates on negative amortization or minimum payment option loans

can be as low as 1%. This is the payment rate, not the actual interest

rate. The payment rate is used to calculate the minimum payment. Other minimum payment options

include 1.95% or more.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 24: Amortization

Negative amortization - NegAm - mortgage terminology

1 :** F.I.R. times the principal balance, divided by 12 months (with no

amortization or reduction in the owed balance).

https://store.theartofservice.com/the-amortization-toolkit.html

Page 25: Amortization

Negative amortization - Criticisms

1 Negative-amortization loans, being relatively popular only in the last

decade, have attracted a variety of criticisms:

https://store.theartofservice.com/the-amortization-toolkit.html

Page 26: Amortization

Negative amortization - Criticisms

1 In addition, most negative amortization loans contain a clause saying that the payment may not

increase more than 7.5% each year, except if the 5-year period is over or

if the balance has grown by 15%

https://store.theartofservice.com/the-amortization-toolkit.html

Page 27: Amortization

Negative amortization - Criticisms

1 * Negative-amortization loans as a class have the highest potential for what is known as payment shock. Payment shock is when the required monthly payment jumps from

one month to the next, potentially becoming unaffordable. To compare various mortgages' payment-shock potential (note that the items here do not include escrow payments for insurance and taxes, which

can cause changes in the payment amount):

https://store.theartofservice.com/the-amortization-toolkit.html

Page 28: Amortization

Negative amortization - Criticisms

1 ** A 10-year interest only mortgage product, recasting to a 20-year

amortization schedule (after ten years of interest-only payments)

could see a payment increase of up to $600 on a balance of 330K.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 29: Amortization

Negative amortization - Criticisms

1 ** Negative amortization mortgage: no payment jump either until 5 years OR the

balance grows 15% (depending on the product) higher than the original amount. The payment increases, by requiring a full

interest-plus-principal payment. The payment could further increase due to

interest-rate changes. However, all things being equal, the fully amortized payment is

almost triple the negatively amortized payment.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 30: Amortization

Negative amortization - Difference between negative amortization and a reverse mortgage

1 This early stage is known as the negative amortization or NegAm

period

https://store.theartofservice.com/the-amortization-toolkit.html

Page 31: Amortization

Amortization calculator

1 An 'amortization calculator' is used to determine the periodic payment

amount due on a loan (typically a mortgage loan|mortgage), based on

the amortization (business)|amortization process.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 32: Amortization

Amortization calculator

1 The amortization (business)|amortization repayment model factors varying amounts of both interest and principal into every

installment, though the total amount of each payment is the same.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 33: Amortization

Amortization calculator

1 The amortization schedule is a table delineating these figures across the duration of the loan in chronological

order

https://store.theartofservice.com/the-amortization-toolkit.html

Page 34: Amortization

Amortization calculator - Derivation of the formula

1 The formula for the periodic payment amount A is derived as follows. For an amortization schedule, we can

define a function p(t) that represents the principal amount remaining at

time t. We can then derive a formula for this function given an unknown payment amount A and r = 1 + i.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 35: Amortization

Amortization calculator - Other uses

1 While often used for mortgage-related purposes, an amortization

calculator can also be used to analyze other debt, including short-term loans, student loans and credit

cards.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 36: Amortization

Tax amortization benefit

1 In Valuation (finance), 'tax amortization benefit' (or 'tax

amortisation benefit') refers to the present value of income tax savings

resulting from the tax deduction generated by the amortization of an

intangible asset.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 37: Amortization

Tax amortization benefit - Intangible asset valuation

1 2007.] Specifically, the fair market value of the asset is increased by the

present value of the future tax savings derived from the tax

amortization of the asset

https://store.theartofservice.com/the-amortization-toolkit.html

Page 38: Amortization

Tax amortization benefit - Circularity of the tax amortization benefit

1 2011] This circularity can be handled using a two-step procedure consisting in

estimating the value of the intangible asset in the absence of the tax amortization benefit first and then grossing up the

previous value by a tax amortization benefit factor.[http://www.taxamortisation.com/theo

retical-background.html See section Calculating the TAB section about two-step

procedure to solve the circularity issue]

https://store.theartofservice.com/the-amortization-toolkit.html

Page 39: Amortization

Tax amortization benefit - Circularity of the tax amortization benefit

1 # t is the corporate tax rate applicable to the future amortization of the asset

https://store.theartofservice.com/the-amortization-toolkit.html

Page 40: Amortization

Tax amortization benefit - Circularity of the tax amortization benefit

1 For example, while trademarks can have an indefinite useful life for accounting purposes,

the tax legislation of the United States establishes a mandatory 15-year

amortization period for trademarks.[http://www.irs.gov/Businesses/Pa

rtnerships/Partnership---Audit-Technique-Guide---Chapter-3---Contribution-of-Property-

with-Built-in-Gain-or-Loss---IRC-section-704(c)-(Revised-12-2007)#13 IRC SECTION 704(c) AND IRC SECTION 197 INTANGIBLES]

https://store.theartofservice.com/the-amortization-toolkit.html

Page 41: Amortization

Amortization (business)

1 In business, 'amortization' refers to spreading payments over multiple periods. The term is used for two

separate processes: amortization of loans and amortization of intangible

assets.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 42: Amortization

Amortization (business) - Amortization of loans

1 A greater amount of the payment is applied to interest at the beginning of the amortization schedule, while

more money is applied to principal at the end

https://store.theartofservice.com/the-amortization-toolkit.html

Page 43: Amortization

Amortization (business) - Amortization of loans

1 where: P is the principal amount borrowed, A is the periodic

amortization payment, r is the periodic interest rate divided by 100

(nominal annual interest rate also divided by 12 in case of monthly installments), and n is the total

number of payments (for a 30-year loan with monthly payments n = 30

× 12 = 360).https://store.theartofservice.com/the-amortization-toolkit.html

Page 44: Amortization

Amortization (business) - Amortization of loans

1 Negative amortization (also called deferred interest) occurs if the

payments made do not cover the interest due. The remaining interest owed is added to the outstanding

loan balance, making it larger than the original loan amount.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 45: Amortization

Amortization (business) - Amortization of intangible assets

1 In accounting, amortization refers to expensing the acquisition cost minus

the residual value of intangible assets (often intellectual property such as patents and trademarks or copyrights) in a systematic manner

over their estimated useful economic lives so as to reflect their

consumption, expiry, obsolescence or other decline in value as a result

of use or the passage of time.https://store.theartofservice.com/the-amortization-toolkit.html

Page 46: Amortization

Amortization (business) - Amortization of intangible assets

1 A corresponding concept for tangible assets is depreciation.

Methodologies for allocating amortization to each accounting

period are generally the same as for depreciation. However, many

intangible assets such as Goodwill (accounting)|goodwill or certain

brands may be deemed to have an indefinite useful life and are

therefore not subject to amortization (although goodwill is subjected to an

impairment test every year).

https://store.theartofservice.com/the-amortization-toolkit.html

Page 47: Amortization

Amortization (business) - Amortization of intangible assets

1 Amortization is recorded in the financial statements of an entity as a reduction in the book value|carrying value of the intangible asset in the balance sheet and as an expense in

the income statement.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 48: Amortization

Amortization (business) - Amortization of intangible assets

1 Under International Financial Reporting Standards, guidance on accounting for the amortization of

intangible assets is contained in IAS 38. Under Generally Accepted

Accounting Principles (USA)|United States generally accepted accounting

principles (GAAP), the primary guidance is contained in FAS 142.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 49: Amortization

Amortization (business) - Amortization of intangible assets

1 While theoretically amortization is used to account for the decreasing value of an

intangible asset over its useful life, in practice, many companies will amortize what would otherwise be one-time expenses by listing them as a capital expense on the cash flow statement and paying off the cost through

amortization, thereby improving the company's net income in the fiscal year or

quarter of the expense.wikinvest:Amortization|Wikinvest's Coverage of Amortization

https://store.theartofservice.com/the-amortization-toolkit.html

Page 50: Amortization

Amortization schedule

1 The percentage of interest versus principal in each payment is

determined in an amortization schedule

https://store.theartofservice.com/the-amortization-toolkit.html

Page 51: Amortization

Amortization schedule

1 An amortization schedule reveals the specific monetary amount put towards interest, as well as the specific amount put towards the

principal balance, with each payment

https://store.theartofservice.com/the-amortization-toolkit.html

Page 52: Amortization

Amortization schedule - Methods of amortization

1 There are different methods in which to arrive at an amortization schedule. These include:

https://store.theartofservice.com/the-amortization-toolkit.html

Page 53: Amortization

Amortization schedule - Methods of amortization

1 Amortization schedules run in chronological order. The first

payment is assumed to take place one full payment period after the

loan was taken out, not on the first day (the amortization date) of the loan. The last payment completely pays off the remainder of the loan. Often, the last payment will be a slightly different amount than all

earlier payments.https://store.theartofservice.com/the-amortization-toolkit.html

Page 54: Amortization

Amortization schedule - Methods of amortization

1 In addition to breaking down each payment into interest and principal portions, an amortization schedule also reveals interest-paid-to-date,

principal-paid-to-date, and the remaining principal balance on each

payment date.

https://store.theartofservice.com/the-amortization-toolkit.html

Page 55: Amortization

Amortization schedule - Example amortization schedule

1 This amortization schedule is based on the following

assumptions:

https://store.theartofservice.com/the-amortization-toolkit.html

Page 56: Amortization

Amortization schedule - Example amortization schedule

1 'Re-amortization' or restarting the amortization schedule via a refinance causes the entire schedule to restart:

the new loan will be 30 years from the refinance date, and initial

payments on this loan will again be largely interest, not principal

https://store.theartofservice.com/the-amortization-toolkit.html