Understanding Amortization: Functions, Accounting Roles, and Financial Implications
Functions of Amortization
1) Juridical: Amortization accounts for the depreciation of fixed assets used in the production process. Without it, financial assessments would be inaccurate.
2) Economic: Amortization distributes the depreciation (consumption) of fixed assets over time. The total amount of this consumption is known at the end of the asset’s useful life.
3) Financial: Amortization ensures the availability of liquid assets for the renewal of fixed assets. It allows the entity to maintain its capital and transform fixed assets into liquid assets.
Role of Accounting for Amortization
There are two systems:
- Direct System: The asset account is directly amortized, with the corresponding entry being the amortization expense.
- Indirect System: The amortization is recorded in a contra-asset account, such as accumulated depreciation for tangible or intangible assets.
External and Internal Results
External Result: The difference between revenue and expenditure during a period.
Internal Result: The difference between net sales and the cost of goods sold.
Internal Result = Net Sales – Cost of Sales
Cost of Sales = Beginning Inventory + Net Purchases – Ending Inventory
Patrimonial Synthesis (Annual Accounts)
Includes the balance sheet, profit and loss statement (P&L), statement of changes in equity, cash flow statement, and notes to the financial statements.
Formulation of Annual Accounts
Annual accounts are prepared with a periodicity of 12 months by the employer or administrators. The balance sheet, P&L, statement of changes in equity, cash flow statement, and notes must be identified and expressed in euros.
Legal Requirements
Individual entrepreneurs or administrators are required to prepare annual accounts within 3 months from the accounting year-end.
Annual accounts must be valued in euros and verified by auditors. Approval occurs at a general meeting of shareholders, followed by profit distribution.
Principle of Correlation of Income and Expenditure
The result for a period consists of revenues generated in that period less the expenses incurred to obtain those revenues.
Functional Classification of Economic Units
- Consumer Units: Entities that use property to satisfy needs through consumption.
- Production Units: Entities that generate a surplus through management accounting, referred to as lucrative capital (owner’s contribution).
General Accounting Plan
The key binding parts are: Framework, recording and valuation rules, and annual accounts.
Definitions
Admission: The right to charge for a transaction caused by the transfer of goods or services.
Debit Balance: When the sum of debits is greater than the sum of credits.
Cost: The purchase of a good or service with utility, creating a payment obligation.
Expenditure: A decrease in assets or net worth. The use or consumption of a cost in an accounting period leads to a decrease in assets.
Collections: The input of money that cancels the right to collection.
Amortization: The accounting expression of the systematic depreciation of a fixed asset due to its productive use. It is an expense process.
Financing Origins (Creation of Availability)
Financial Structure [Equity Funding + Debt Funding] —> [Fixed Assets Investment / Financial Investments + Current Assets / Current Investments] — Imputation —> [Cost System] – Sales, Income —> [Economic Environment] (arrow from economic environment to the second table and put financial income)
If PC > PV -> -R
If PC < PV -> R
If PC = PV -> R = 0