Intangible assets amortization is the process of expensing the cost of an asset over its useful life. The accounting treatment of amortization is similar to that of depreciation. An intangible asset is a non-physical asset with a useful life of more than a year. Examples of types of intangible assets are trademarks, computer software goodwill, franchise agreements, and even customer lists.
As tangible assets lose value over time due to their use, intangible assets also wear down due to obsolescence, contract expirations, and other non-physical factors. Intangible assets having a finite useful life are treated similarly to physical assets, i.e., a part of their cost is treated as an expense. While intangible assets having an infinite life does not get amortized.
What is Intangible Assets Amortization?
For tangible assets, we use depreciation to spread out the cost of the asset over its useful life. For the intangible asset, we use amortization to spread the cost as an expense over its useful life. Amortization expense is also a part of the income statement, representing a periodic allocation of cost as an expense. The carrying amount of the intangible asset in the balance sheet shows after the reduction of the amount of amortization expense.
The accountant can also choose to create an accumulated amortization account which shows the total amortization expense charged for that asset since its acquisition. In this case, the amount of intangible assets in the balance sheet is not required to be reduced.
Are Depreciation and Amortization Different?
The only major difference between depreciation and amortization is that the latter is related to intangible assets, while the former is to tangible assets. Amortization applies only to intangible assets with a finite useful life. Amortization does not apply to assets with infinite useful life, like goodwill.
Periodical evaluation of such assets can check if they now have a determinable useful life. Or if their value has become impaired. Impairment of intangible assets is a separate topic, and to know more, refer to the article impairment of Long-Lived Assets.
How to Calculate Amortization?
Like depreciation, there are also various methods one can use for the amortization of intangible assets. However, the most used and simplest method is the straight-line method. It is always advisable to use the straight-line method unless there is any pattern of economic benefit you can foresee from the intangible asset. In such cases, accountants may adopt an amortization method that best reflects that pattern.
In the straight-line method, the amount for amortization is the recorded cost of the intangible asset, less any residual value, and then it is divided by the asset’s useful life. Usually, intangible assets don’t have any residual value. Therefore the full cost of the asset is amortized.
Intangible Asset Amortization Example
Let us understand how to amortize intangible assets with a business case. A company named XYZ acquires a patent for $35,000 that will expire after 10 years. So, the patent’s useful life, in this case, is ten years.
Based on the straight-line method, the company will amortize $3,500 each year (that is, $35,000/10) for the next ten years. Each year $3,500 will become part of an expense in the income statement. The intangible asset will reflect the amount net of amortization expense in the balance sheet.
Now, consider a case where, after seven years, XYZ found that the patent has become worthless. In such a case, the cost of the asset has already been amortized by $3,500 each year for seven years. The remaining unamortized cost, i.e., $10,500, will become an expense of the company, and on the balance sheet, the value of the assets turns to zero.
Advantages of Amortization
Easy Value Assessment
Amortization helps a business to easily assess the value of the amortized asset.
Amortization helps in evaluating the benefits of owning a specific asset
Lower Tax Burden
Intangible assets amortization helps lower the tax burden (businesses often use a different amortization method for tax purposes).