Amortization and Accretion
Amortization is the gradual writing off of the cost of an asset over its useful life. Tangible assets, such as machinery, decline in value over time because they age with use or become obsolete. The amortization of tangible assets is usually called depreciation.
The term amortization also applies to intangible assets. Intangible assets refer to that portion of an asset whose cost exceeds its book value. When a bond is bought at premium, for example, the premium is an intangible asset. Intangible assets are typically assets that can’t be touched or held, such as patents or trademarks. They decline in value over time, in the case of patents or trademarks, as they approach their expiration dates.
A municipal bond’s premium operates the same way as the principal of a home mortgage. Rather than pay back the entire principal of a home mortgage on its redemption date, the principal is amortized, or gradually paid down, over the life of the loan. Likewise, when a tax-exempt municipal bond is purchased at a premium, the bondholder will write off the premium over the remaining life of the bond. The amortized amount is not deductible in determining taxable income. However, it is reported to the IRS and deducted each year from the purchaser’s reportable tax-exempt interest.
Not all assets depreciate over time