Intangible assets amortization is the process of expensing the cost of an asset over its useful life. Treatment of amortization & depreciation is similar. An intangible asset is a non-physical asset with a useful life of more than a year. Like other assets, they are also reflected in the company’s balance sheet. Examples of intangible assets are trademarks, computer software goodwill, franchise agreements, and even customer lists.
While tangible assets lose value over time due to their use, the intangible assets wear down due to obsolescence, contract expirations, and other non-physical factors. Intangible assets having a finite useful life are treated similarly to the physical assets, i.e., a part of their cost is treated as an expense.
What is Intangible Assets Amortization?
For the 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 their useful life. Hence, it is the process of expensing the cost of the asset over its estimated useful life.
Process and treatment of intangible assets, amortization, and depreciation are very similar. Like depreciation, 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.
Depreciation and Amortization – Are they 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.
Intangible assets amortization accounting treatment is also very similar to depreciation. The amortized amount becomes part of an expense in the income statement. In the balance sheet, the intangible asset is shown net of the accumulated amortization balance, which is the total amortization expense charged for that asset since its acquisition.
How to Calculate Amortization?
Like depreciation, there are many methods one can use for the amortization of intangible assets. However, the most used and the 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. Usually, intangible assets don’t have any residual value. Therefore the full cost of the asset is amortized.
Furthermore, the method to calculate amortization is also the same as calculating depreciation with the Straight-line method. The residual value (if any) is subtracted from the cost, and then it is divided by the asset’s useful life.
Intangible Asset Amortization Example
Let us understand this with a business case. A company named XYZ acquires a patent for $10,000 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 $1,000 each year for the next ten years. Each year $1,000 will become part of an expense in the income statement, while in the balance sheet, accumulated amortization will increase by $1,000. The intangible asset will be shown as a net of accumulated amortization in the balance sheet.
Now, consider a case where, after five years, XYZ found that the patent has become worthless. In such a case, the cost of the asset has already been amortized by $1,000 each year for five years. The remaining unamortized cost, i.e., $5,000, will form part of expenses, and on the balance sheet, the value of the assets turns to zero.
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).