What Is Intangible Asset Amortization?
A technique known as amortization of intangibles is used to expense the cost of an intangible asset over the asset’s anticipated life for tax or accounting purposes. Patents and trademarks are intangible assets amortized into an expenditure category called amortization. Depreciation is used to write off tangible assets instead. The method of amortization utilized for corporate accounting and the amount used for tax purposes may differ.
Understanding Intangible Asset Amortization
Regardless of the asset’s real useful life (because most intangibles don’t have a fixed useful life), the cost basis of an intangible asset is amortized over a certain number of years for tax reasons. If an asset falls under Section 197, the Internal Revenue Service (IRS) permits amortization over 15 years.
Non-physical assets that have a monetary worth are known as intangible assets. The phrase “intellectual property” (IP), which covers the majority of intangible assets, is recognized as an intangible asset. Section 197 covers the majority of IP. Patents, goodwill, trademarks, and trade and franchise names are a few examples of these Section 197 intangible assets.
However, not all IP gets amortized during the allotted 15 years by the IRS. There are several exceptions, including software bought in a transaction easily accessible to the general public, covered by a nonexclusive license, and hasn’t undergone significant modification. In certain circumstances and a few others, intangibles are amortized by Section 167.
When a parent firm buys a subsidiary business and pays more than the net assets of the subsidiary’s fair market value (FMV), the excess is recorded as goodwill, an intangible asset. IP is originally recorded as an asset on the company’s balance sheet when bought.
Additionally, a company’s research and development (R&D) operations might produce IP. An organization could obtain a patent for a recently created technique with some value. That value must be properly recognized since it raises the company’s worth.
In either scenario, the amortization process enables the business to deduct annually, per a predetermined schedule, a portion of the value of that intangible asset.
Depreciation vs. Amortization
Businesses employ assets to make income and generate revenue. As the asset’s usable life shortens over time, the expenditures associated with it are gradually transferred into an expense account. The corporation complies with GAAP, which mandates that revenue be matched with the expense paid to produce revenue by depreciating the asset’s cost over time.
Depreciation costs physical assets, whereas amortization is used to expense intangible assets. The physical asset’s salvage value, or the price it may be sold for at the end of its useful life, is typically included in depreciation. Salvage value is not taken into consideration during amortization.
A corporation chooses six amortization techniques for accounting (financial statement) purposes: straight line, falling balance, annuity, bullet, balloon, and negative amortization. For accounting reasons, there are only four acceptable depreciation techniques: straight line, decreasing balance, the sum of years’ digits, and output units.
The IRS permits two methods for amortizing intangibles for taxation purposes. These are the income projection technique and the straight line. If the asset is one of the following: motion picture films, videotapes, sound recordings, copyrights, publications, or patents, the revenue prediction approach may be used instead of the straight-line method. The IRS only permits the Modified Accelerated Cost Recovery System (MACRS) to depreciate tangible assets.
A case study of amortization
Consider a construction business purchasing a $32,000 vehicle with an eight-year useful life for contractor work. The straight-line yearly depreciation cost equals the $32,000 cost base less the $4,000 projected salvage value, divided by eight years. The truck would depreciate by $3,500 yearly, or ($32,000 – $4,000) x 8.
On the other hand, suppose a business invests $300,000 on a patent that grants it 30-year exclusivity over the intellectual property. For 30 years, the company’s accounting division has recorded an annual amortization expenditure of $10,000.
Over a specific period, the vehicle and the patent are employed to create income and profit. Depreciation is utilized because the vehicle is a physical asset, whereas amortization is used because the rights are intangible.
What Is the Definition of Intangible Asset Amortization?
Over their lifetime, the process of depreciating expenditures related to intangible assets, such as patents and trademarks, is referred to as amortization of intangibles. This is carried out for accounting or tax purposes. These assets are expensed into an amortization account, often known as amortization.
How Are Intangible Assets Amortized Calculated?
The amortization of intangibles can be calculated in several different ways. The straight-line technique, which includes expensing the asset over time, is the most typical way to achieve this. The cost of the asset, less its estimated salvage value or book value, is subtracted from the total number of years it will be used, and the result is the amortization rate.
Where Can You Find Intangible Asset Amortization in Financial Statements of a Company?
Intangible asset amortization, or amortization for short, is a line item under costs on a company’s profit and loss statement. This sum is also included in the non-current assets part of company balance sheets.
- The cost of an intangible asset is progressively incurred or written off over time through amortization.
- Depreciation is used for tangible (physical) assets, whereas amortization is used for intangible (non-physical) assets.
- Different forms of intellectual property, like as patents, goodwill, trademarks, etc., might be considered intangible assets.
- For tax reasons, most intangibles must be amortized over the years.
- Six different amortization techniques are used in accounting: balloon, falling balance, annuity, bullet, and straight line.