Introduction to Amortization

In this section, the speaker introduces the topic of amortization and outlines the objectives of the presentation.

Definition and Purpose of Amortization

• Amortization is a method used to reflect the periodic loss or depreciation of value for assets or decrease in credit for liabilities.

• It involves systematically reducing the value of an asset over time or decreasing a liability.

• The simplest way to calculate amortization is through linear or straight-line amortization.

Linear Amortization Calculation Example

• To calculate linear amortization, use the formula: amortization = acquisition price / useful life.

• For example, if a computer is purchased for $1000 with a useful life of 4 years, the annual amortization would be $250 ($1000 / 4).

• The accumulated amortization at the end of each year will be equal to the sum of all previous annual amortizations.

Methods of Amortization

This section explains two methods of amortization - French and German methods.

French Method (Constant Installments)

• Also known as constant installment method.

• Payments are made in equal installments throughout the specified period.

• Suitable when interest rate remains fixed from the beginning.

German Method (Decreasing Installments)

• Also known as decreasing installment method.

• Payments are gradually reduced relative to interest payments while keeping amortizations constant.

• Suitable when interest payments need to be analyzed separately from principal repayments.

Calculation Example - French Method

This section provides an example calculation using the French method.

Formula for French Method

amortization = loan amount * (interest rate + 1)^n / ((interest rate + 1)^n - 1)

• Loan amount: $10,000

• Interest rate: 0.05

• Number of periods (n): 6

Calculation Steps

1. Calculate the amortization using the formula mentioned above.

2. Calculate the interest payment by multiplying the loan amount with the interest rate.

3. Subtract the interest payment from the installment to get the amortization.

4. Repeat these steps for each period.

Calculation Example - German Method

This section provides an example calculation using the German method.

Formula for German Method

amortization = loan amount / useful life

• Loan amount: $10,000

• Useful life: 6 months

• Monthly installment: $6

Calculation Steps

1. Divide the loan amount by useful life to calculate constant monthly amortization.

2. Calculate interest payment by multiplying remaining balance with interest rate.

3. Subtract interest payment from monthly installment to get principal repayment.

4. Repeat these steps for each period.

Conclusion and Summary

In this section, a brief summary of amortization is provided along with a reminder about the French and German methods.

Key Points

• Amortization reflects the loss of value for assets or decrease in credit for liabilities over time.

• The French method involves constant installments, while the German method has decreasing installments relative to interest payments.

• Understanding different methods of amortization helps in financial analysis and decision-making processes.

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