When a business negotiates a loan to operate or expand the business or purchase or refinance business property, significant loan costs must be amortized to satisfy the matching principle. The matching principle requires matching, or allocating, the loan costs to the accounting periods during which any of the loan balance still exists, called the "life" of the loan. Amortization is similar to depreciation, which allows an expense deduction each year for a percentage of a fixed asset's cost over the useful life of the asset.
Examine the loan closing statement to calculate the costs of the loan. Include all fees, commissions, points and loan preparation costs. Do not include payments made through escrow for property taxes, outstanding bills paid to creditors or interest payments to another lender; these costs are deductible as expenses in the first year of the loan. Total the costs to be amortized, then check the closing statement for any credits or reimbursements that reduce these costs. Deduct credits and reimbursements from the total. Add any additional costs not included in the closing statement, such as legal and accounting fees, registration fees or regulatory fees. The result is the amount to which amortization applies.
Read the loan document to determine the life of the loan and the amortization periods. For example, if a loan is payable over a period of 120 months and loan costs are $50,000, divide the amortized costs by 120. In this case, the allowable amortization expense is $416.67 each month. Set up an amortized loan costs account and a contra account for accumulated amortization on the "fixed asset" section of the balance sheet. Set up an amortization expense account, and debit $416.67 each month as amortization expense. Credit the accumulated amortization account for the same amount.
Create an amortization schedule detailing the total amortized costs, the monthly amortization expense deducted and the remaining balance at the end of each month over the life of the loan. If the business pays the loan off early, any remaining balance of amortized costs is deductible in the month the loan is fully paid.
Each loan payment generally includes both principle and interest. Loan principle is not an expense, but is deducted from the loan balance. Loan interest is deductible as it is paid or accrued. Set up a separate amortization schedule for loan payments.