AMORTIZATION, the paying off of a debt or obligation, or the extinguishment of an asset by means of a series of partial payments or charges, prorated to extend over the period during which the obligation or asset will exist. Such amortization pay ments are usually in annual or semi-annual amounts, each of which is sufficient to cover the interest, if any, and also to pro vide for a certain reduction of the principal.
The amortization principle is used in finance for the purpose of obliterating the premium or discount on bonds which are bought or sold above or below their par value. As bonds ap proach their maturity date, at which time they will be paid off at par, their carrying value approaches their par value, actually reaching it at the time of redemption. If such bonds have been bought or sold at a premium or at a discount then such premium or discount must be amortized by the time of maturity in order to bring these two values to a point of coincidence in the accounts. If a bond is bought above par, at a premium, and repaid at par, the owner loses an amount equal to the premium; if it is bought below par, at a discount, and redeemed at par, the owner gains an amount equal to the discount. If the bond is sold above par, at a premium, and redeemed at par, the issuer gains an amount equal to the premium ; if it is sold below par, at a discount, and re deemed at par, the issuer loses an amount equal to the discount.
This premium or discount which is gained or lost as the case may be, should be amortized over the life of the bond by periodic charges or credits.
The amortization of bond discount by the issuers will work out as follows. A thousand dollar 5% bond is sold at 8o% of its face value. This increases the company's liabilities by $I,000 and in creases its assets by the amount of cash realized, $800. The dif ference of $200 is the bond discount and is entered under this name as an asset. This is, of course, only a balancing item or practically a dummy asset, and if the company is to make its real assets equal to its increased liabilities it must add to its property an amount equal to $ 200. The most usual way is to lay aside from earnings annually a predetermined sum either fixed (approximate method) or varying (scientific method), which over the life of the bond will amount to the discount of $200. Amortization of premiums may be accomplished in a similar manner.
BIBLIOGRAPHY.—L. Perrine and C. E. Sprague, Accountancy of InBibliography.—L. Perrine and C. E. Sprague, Accountancy of In- vestment (rev. ed., 1914) ; J. V. Toner, Mathematics of Finance (1926) ; H. A. Finney, Principles of Accounting ; W. S. Schlauch and Theo. Lang, Mathematics of Business and Finance.