10-25-2017, 11:19 AM

Submitted By ;

Submitted To ;

SYED NAIF AMJAD

Subject ;

ACCOUNTING

Topics ;

AMORTIZATION AND ACCRUALS

Date ;

03/01/2013

contents

Chapter 1

AMORTIZATION

1.1 What is Amortization ?

1.2 What is Intangible Asset ?

1.3 What is Patent ?

1.4 Formula for Amortization

1.5 Numerical examples

1.6 Amortization Schedule

1.7 What is Mortgage ?

1.8 Passing Entry for Amortization

Chapter 2

ACCURALS

2.1 What is Accrual ?

2.2 What is Invoice ?

2.3 Matching Principle

2.4 Numerical Examples

2.5 Recognition Process

What is Amortization?

Amortization is process of paying off a debt (often from a loan or mortgage) over time is determined in an amortization schedule. 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

OR

The gradual elimination of a liability, such as a mortgage, in regular payments over a specified period of time. Such payments must be sufficient to cover both principal and interest.

The example.principal is the amount of money borrowed in the loan. If you get a loan for $250,000, the principal of the loan is $250,000. As you pay off the loan, the principal balance decreases. After 20 years, the principal balance (often just referred to as the balance) may be $135,000 for

The interest rate (or annual interest rate) is used to determine how much money is paid back to the lender in each payment period. In traditional loans, a calculation is performed with the remaining balance to determine how much of the payment goes toward interest.

The term is the length of a loan or mortgage usually measured in years or months. It is important to note that the term length does not always indicate the number of payments involved in the loan. A 15-year mortgage often will have 180 monthly payments (15 years x 12 months = 180).

Example;

Suppose XYZ Biotech spent $30 million dollars on a piece of medical equipment and that the patent on the equipment lasts 15 years, this would mean that $2 million would be recorded each year as an amortization expense.

While amortization and depreciation are often used interchangeably, technically this is an incorrect practice because amortization refers to intangible assets and depreciation refers to tangible assets.

What is Intangible Asset ?

Definition of 'Intangible Asset'

An asset that is not physical in nature. Corporate intellectual property (items such as patents, trademarks, copyrights, business methodologies), goodwill and brand recognition are all common intangible assets in today's marketplace. An intangible asset can be classified as either indefinite or definite depending on the specifics of that asset. A company brand name is considered to be an indefinite asset, as it stays with the company as long as the company continues operations. However, if a company enters a legal agreement to operate under another company's patent, with no plans of extending the agreement, it would have a limited life and would be classified as a definite asset

What is Patent ?

A patent is the exclusive right granted by a government to an inventor to manufacture, use, or sell an invention for a certain number of years.

What is the Formula for Amortization ?

Formula for Amortization ;

The basic amortization formula relies on three variables, identified by the letters "P," "R" and "N." You'll work with these to determine your monthly payment, or "M." The first variable, P, is the loan principal. This is the actual amount of money you're borrowing. The second variable, R, is the monthly interest rate, expressed as a decimal. The final variable, N, is the number of months in the loan term.

Example

Say you're taking out a $500,000 mortgage at 7 percent interest for 30 years. You know P already: $500,000. And N is also easy to determine: 30 years equals 360 months, so N is 360. The monthly interest rate, R, is a little trickier. The mortgage has a 7 percent annual interest rate; 7 percent is just another way of saying 7/100, or 0.07. That's the annual rate. Divide that number by 12 to get the monthly rate: 0.0058. Now you're ready to plug the variables into the formula.

Formula

Start by adding (1 + R), then raising the result to the Nth power. Using the variables given above: 1 + 0.0058 = 1.0058 1.0058^360 = 8.0202 . Call this new number "D." Now plug your numbers into this formula: (R x D)/(D - 1). Using the variables given above: (0.0058 x 8.0202) / (8.0202 - 1) = 0.0465 / 7.0202 = 0.0066 Finally, multiply this last number by P, the principal of the loan, to get M, your monthly payment: M = 0.0066 x $500,000 = $3,300 Your monthly payment for principal and interest would be about $3,300.

Our formula becomes ;

[ R X ( R + 1 )^ n ]

M = ------------------------------------ x P

[ ( R + 1)^ n - 1 ]

Where

R is the monthly interest rate

n is the number of months

M is the monthly payment which comprises of both principal

and interest amount

P is the principal amount

[ 0.0058 X ( 0.0058 + 1 )^360 ]

----------------------------------------------------- x 500,000

[ ( 0.0058 + 1)^360 - 1 ]

0.0465

M = -------------------------- = 0.0066 x 500,000

7.0202

M = $3,300

Considerations

Though your total monthly principal and interest payment won't change, the proportion will. Your first payments will be mostly interest and a little bit of principal. With each successive payment, you'll pay more toward the principal and less in interest. In the example above, an early payment might be $400 in principal and $2,900 in interest. Twenty years into the loan, the amounts will be roughly equal, and for a payment in the 30th year, you might pay $3,200 in principal and $100 in interest

Warning

The monthly payment calculated by amortization covers only the principal and interest. Your lender may require you to pay your property taxes and homeowners' insurance premiums as part of your monthly payment. If so, your actual monthly payment will be higher, and it will change to reflect your taxes and insurance costs

What is an amortization schedule ?

Amortization Schedule ;

An amortization schedule is a table detailing each periodic payment on an amortizing loanA 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.

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. Initially, a large portion of each payment is devoted to interest. As the loan matures, larger portions go towards paying down the principal.

What is Mortgage ?

Mortgage ;

A legal agreement that conveys the conditional right of ownership on an asset or property by its owner (the mortgagor) to a lender (the mortgagee) as security for a loan. Virtually any legally owned property can be mortgaged, although real property (land and buildings) are the most common.

A home buyer or builder can obtain financing (a loan) either to purchase or secure against the property from a financial institution, such as a bank or credit union, either directly or indirectly through intermediaries. Features of mortgage loans such as the size of the loan, maturity of the loan, interest rate, method of paying off the loan, and other characteristics can vary considerably.

How can we pass entry for Amortization ??

Example ;

When the intangible asset is originally purchased the cost should be debited to an asset account. This cost is then "written off" or amortized, generally using the straight line method, over the legal useful life of the asset. The straight line method is simply dividing the initial cost of the asset by its useful life. For example if a patent is purchased for $12,000 and amortized over 15 years (180 months) then the monthly write-off would be $66.67 (12,000/180).

Submitted To ;

SYED NAIF AMJAD

Subject ;

ACCOUNTING

Topics ;

AMORTIZATION AND ACCRUALS

Date ;

03/01/2013

contents

Chapter 1

AMORTIZATION

1.1 What is Amortization ?

1.2 What is Intangible Asset ?

1.3 What is Patent ?

1.4 Formula for Amortization

1.5 Numerical examples

1.6 Amortization Schedule

1.7 What is Mortgage ?

1.8 Passing Entry for Amortization

Chapter 2

ACCURALS

2.1 What is Accrual ?

2.2 What is Invoice ?

2.3 Matching Principle

2.4 Numerical Examples

2.5 Recognition Process

What is Amortization?

Amortization is process of paying off a debt (often from a loan or mortgage) over time is determined in an amortization schedule. 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

OR

The gradual elimination of a liability, such as a mortgage, in regular payments over a specified period of time. Such payments must be sufficient to cover both principal and interest.

The example.principal is the amount of money borrowed in the loan. If you get a loan for $250,000, the principal of the loan is $250,000. As you pay off the loan, the principal balance decreases. After 20 years, the principal balance (often just referred to as the balance) may be $135,000 for

The interest rate (or annual interest rate) is used to determine how much money is paid back to the lender in each payment period. In traditional loans, a calculation is performed with the remaining balance to determine how much of the payment goes toward interest.

The term is the length of a loan or mortgage usually measured in years or months. It is important to note that the term length does not always indicate the number of payments involved in the loan. A 15-year mortgage often will have 180 monthly payments (15 years x 12 months = 180).

Example;

Suppose XYZ Biotech spent $30 million dollars on a piece of medical equipment and that the patent on the equipment lasts 15 years, this would mean that $2 million would be recorded each year as an amortization expense.

While amortization and depreciation are often used interchangeably, technically this is an incorrect practice because amortization refers to intangible assets and depreciation refers to tangible assets.

What is Intangible Asset ?

Definition of 'Intangible Asset'

An asset that is not physical in nature. Corporate intellectual property (items such as patents, trademarks, copyrights, business methodologies), goodwill and brand recognition are all common intangible assets in today's marketplace. An intangible asset can be classified as either indefinite or definite depending on the specifics of that asset. A company brand name is considered to be an indefinite asset, as it stays with the company as long as the company continues operations. However, if a company enters a legal agreement to operate under another company's patent, with no plans of extending the agreement, it would have a limited life and would be classified as a definite asset

What is Patent ?

A patent is the exclusive right granted by a government to an inventor to manufacture, use, or sell an invention for a certain number of years.

What is the Formula for Amortization ?

Formula for Amortization ;

The basic amortization formula relies on three variables, identified by the letters "P," "R" and "N." You'll work with these to determine your monthly payment, or "M." The first variable, P, is the loan principal. This is the actual amount of money you're borrowing. The second variable, R, is the monthly interest rate, expressed as a decimal. The final variable, N, is the number of months in the loan term.

Example

Say you're taking out a $500,000 mortgage at 7 percent interest for 30 years. You know P already: $500,000. And N is also easy to determine: 30 years equals 360 months, so N is 360. The monthly interest rate, R, is a little trickier. The mortgage has a 7 percent annual interest rate; 7 percent is just another way of saying 7/100, or 0.07. That's the annual rate. Divide that number by 12 to get the monthly rate: 0.0058. Now you're ready to plug the variables into the formula.

Formula

Start by adding (1 + R), then raising the result to the Nth power. Using the variables given above: 1 + 0.0058 = 1.0058 1.0058^360 = 8.0202 . Call this new number "D." Now plug your numbers into this formula: (R x D)/(D - 1). Using the variables given above: (0.0058 x 8.0202) / (8.0202 - 1) = 0.0465 / 7.0202 = 0.0066 Finally, multiply this last number by P, the principal of the loan, to get M, your monthly payment: M = 0.0066 x $500,000 = $3,300 Your monthly payment for principal and interest would be about $3,300.

Our formula becomes ;

[ R X ( R + 1 )^ n ]

M = ------------------------------------ x P

[ ( R + 1)^ n - 1 ]

Where

R is the monthly interest rate

n is the number of months

M is the monthly payment which comprises of both principal

and interest amount

P is the principal amount

[ 0.0058 X ( 0.0058 + 1 )^360 ]

----------------------------------------------------- x 500,000

[ ( 0.0058 + 1)^360 - 1 ]

0.0465

M = -------------------------- = 0.0066 x 500,000

7.0202

M = $3,300

Considerations

Though your total monthly principal and interest payment won't change, the proportion will. Your first payments will be mostly interest and a little bit of principal. With each successive payment, you'll pay more toward the principal and less in interest. In the example above, an early payment might be $400 in principal and $2,900 in interest. Twenty years into the loan, the amounts will be roughly equal, and for a payment in the 30th year, you might pay $3,200 in principal and $100 in interest

Warning

The monthly payment calculated by amortization covers only the principal and interest. Your lender may require you to pay your property taxes and homeowners' insurance premiums as part of your monthly payment. If so, your actual monthly payment will be higher, and it will change to reflect your taxes and insurance costs

What is an amortization schedule ?

Amortization Schedule ;

An amortization schedule is a table detailing each periodic payment on an amortizing loanA 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.

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. Initially, a large portion of each payment is devoted to interest. As the loan matures, larger portions go towards paying down the principal.

What is Mortgage ?

Mortgage ;

A legal agreement that conveys the conditional right of ownership on an asset or property by its owner (the mortgagor) to a lender (the mortgagee) as security for a loan. Virtually any legally owned property can be mortgaged, although real property (land and buildings) are the most common.

A home buyer or builder can obtain financing (a loan) either to purchase or secure against the property from a financial institution, such as a bank or credit union, either directly or indirectly through intermediaries. Features of mortgage loans such as the size of the loan, maturity of the loan, interest rate, method of paying off the loan, and other characteristics can vary considerably.

How can we pass entry for Amortization ??

Example ;

When the intangible asset is originally purchased the cost should be debited to an asset account. This cost is then "written off" or amortized, generally using the straight line method, over the legal useful life of the asset. The straight line method is simply dividing the initial cost of the asset by its useful life. For example if a patent is purchased for $12,000 and amortized over 15 years (180 months) then the monthly write-off would be $66.67 (12,000/180).

General Journal

Account Titles/Explanation

Ref

Jan

31

Amortization Expense - Patents

Patents

55

14

66.67

Page: 1

DateAccount Titles/Explanation

Ref

Debit

Credit

20XXJan

31

Amortization Expense - Patents

Patents

55

14

66.67

66.67