Chapter 6 bonus material

Amortization schedule

The “amortization schedule” approach to separating interest from principal payments:

In several different accounting topics (installment sales, long-term receivables, bond accounting, lease
accounting) we require that annuity payments be split between the principle/compounding portion and the
interest portion of the payment.
Why? Because the principal/compounding amount typically impacts a permanent account and the
interest portion typically impacts a temporary account.

How the “amortization schedule” approach works (it is always the same basic format!).You start with a
blank table that has the following headings (this is an EXCELlent place to use your spreadsheet skills):

Date Payment amount Interest portion Principal portion Principal balance

(1) (2) (3) (4)

(1) The payment amount in this schedule is almost always fixed (it is based on a contract) and doesn’t
change over the life of the schedule.
(2) The interest portion is calculated as: Appropriate interest rate * beginning Principal balance.
(3) The principal portion is calculated as: Payment amount – Interest portion.
(4) The principal balance is calculated as: beginning Principal balance – current principal portion.
Example: let’s use an installment sale schedule as an example since that is the first topic we’ll come across
that uses this schedule

Suppose that you make a $50,000 installment sale in which you will receive 10 equal payments at the end
of each year for 10 years. The appropriate interest rate has been determined to be 15%. Complete a
schedule showing the interest and principal payments received under this sale.

Step 1:

Step 2: Now we can complete the schedule (The numbers correspond to the columns above):

(1) the Payment amount is _______________ for each of the 10 years.

(2) the interest portion for the first year is: ________________________ . This is how much interest
income we will recognize for the first year.

(3) the principal portion for the first year is: _________________________. This is the reduction in the
receivable for the first year .

(4) the new principal balance after the first payment will be : _______________.
(Think about this - even though you received $______, most of it was interest so the principal balance
really didn't go down much -- this is the same way your car payments or home mortgages work - even
though you make pretty big payments, the payoff balance only decreases a tiny bit in the early months)
(5) the interest portion for the second year is: YOU FIGURE IT OUT

Over the life of the schedule, the principal balance will go to –0-. Try a few lines. (Look at the completed
schedule in Chapter ___ to see if you did it correctly!)