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What does amortized cost mean in accounting?
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In this article, I will break down the meaning of Amortized Cost so you know all there is to know about it!
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What Is Amortized Cost
An amortized cost refers to an accounting method where financial assets are reported on the balance sheet at their amortized value.
In other words, a financial asset will be reported as having a value equal to its acquisition value less any principal repayments, discounts, premiums, impairment losses, and exchange differences.
You can say that the total cost a business has recorded on its balance for the purchase of a particular asset is the amortized cost of the asset.
Amortized Cost Fixed Assets
The amortized cost for fixed assets is the accumulated portion of the recorded cost of the fixed asset that has been charged to the expense account as depreciation or amortization.
Typically, depreciation is used to reduce to cost of fixed assets whereas amortization is used to reduce the cost of intangible assets.
Amortized cost can also be applied to the accumulated value of depreciation of natural resources that have been charged to the expense account.
Amortized Costs Securities
For securities, amortized cost refers to the positive or negative adjustments for purchase discounts or premiums related to the purchase of securities.
A purchase discount occurs when an investor pays less than the face value of the securities, thereby increasing the security’s effective interest.
A purchase premium is when the investor pays more than the face value of the security thereby reducing the effective interest on the security.
Rate of Amortization on Amortized Cost
The rate of amortization will have an impact on the amortized cost.
Essentially, the higher the amortization rate, depreciation rate, or depletion rate, the more your amortized cost will be higher.
This means that you will accumulate a greater portion of the recorded cost of the fixed asset to expense.
Amortized Cost Definition
How do you define amoritzed cost?
Amortized cost is the initial recognition value of a financial asset or liability less principal payments, plus or minus the cumulative amortization using the effective interest method, and adjustments for any loss allowance.
Amortized Cost Calculation
The amortized cost of a financial instrument is calculated using the effective interest method.
With the effective interest method, you spread interest revenue or interest expense over a relevant period of time thereby amortizing the carrying amount recorded on the initial recognition value to the ultimate contractual cash flows.
You can calculate the amortized cost as follows:
Acquisition amount less principal repayment, plus or minus amortization of discount/premium, plus or minus foreign exchange differences, less impairment losses.
Amortized Cost Convention
Amortized cost is one of three classification and measurement options for financial assets under IFRS 9.
A company must measure at amortized cost when the following two conditions apply:
- The financial asset is held within a business model having an objective to hold financial assets to collect contractual cash flows
- The contractual terms of the financial asset give rise on specified dates to cash flows that are payments of principal and interest at scheduled dates
Amortized Cost vs Fair Value
What is the difference between amortized cost versus fair value?
In essence, there is no particular relationship between the amortized cost of an asset and its market value.
You can have instances where the market value of an asset can be higher or lower than the amortized cost of an asset.
That’s simply a factual state of affairs.
Amortized Cost vs Amortization
What is the difference between amortized cost and amortization?
Amortization refers to the process of deducting portions of the cost of an asset from a company’s revenues over a certain number of years in the future.
For example, using a straight-line amortization method, a company will divide the total cost of an asset over the asset’s estimated useful life and deduct that value from its revenues every year.
Amortized cost refers to the total cost of an asset that a company has already recorded as an expense.
You can determine the amortized cost by multiplying the yearly amortization amount by the number of years that have passed since the amortization began on the asset.
Amortized Cost Example
Let’s look at an example of amortized cost to see how it works.
Imagine that a company purchases an asset worth $100,000 that has an estimated useful life of 10 years.
The company will use a straight-line amortization schedule to deduct $10,000 every year from its revenues and record that as an expense.
After four years, the company will have deducted a total of $40,000 from its revenues.
In year four, the company’s amortized cost is $40,000 as that is the amount the company has deducted from the purchase price of the asset.
In the tenth year, the company’s amortized cost for the asset will be $100,000 as it will have deducted the full purchase value as an expense by that time.
Amortized Cost Meaning Takeaways
So there you have it folks!
What Is Amortized Cost
In a nutshell, the amortized cost is an investment classification and accounting method requiring financial assets to be classified under this method to be reported on the balance sheet at their amortized cost.
The amortized cost equals a financial asset’s initial acquisition amount less principal repayment plus or minus amortization of discount/premium, plus or minus foreign exchange differences less impairment losses.
Now that you know what amortized cost means, how it is calculated, and why it is used, good luck in your accounting!
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