Amortization Of Intangibles

Definition

Amortization of intangibles refers to the process of gradually writing off the cost of intangible assets over their expected useful life. Intangible assets include patents, trademarks, copyrights, franchises, and goodwill. This process is similar to the depreciation of tangible assets, but it applies to intangible assets. The purpose of amortization is to accurately reflect the value of these assets in financial statements and match the economic benefits they generate.

Origin

The concept of amortization of intangibles developed as businesses began to recognize the importance of intangible assets. As intellectual property and brand value became increasingly significant in corporate assets, companies needed a method to allocate the cost of these assets accurately to reflect their value in financial statements.

Categories and Features

Intangible assets include patents, trademarks, copyrights, franchises, and goodwill. Amortization is based on the expected useful life of the intangible asset, usually measured in years. A common method is straight-line amortization, which evenly distributes the cost of the intangible asset over each accounting period. Amortization expenses are reported on the income statement and reduce the book value of intangible assets on the balance sheet.

Case Studies

Consider a company that purchases a patent for $1 million with an expected useful life of 10 years. The company will amortize the patent cost annually, recording $100,000 in amortization expense each year. This amount is reflected in the financial statements, reducing the book value of the intangible asset by $100,000 annually.

Another example is a company that acquires a trademark for $500,000 with a 5-year expected useful life. The company amortizes $100,000 of the trademark cost each year, ensuring the financial statements accurately reflect the trademark's value.

Common Issues

Investors might confuse amortization of intangibles with depreciation. Amortization applies to intangible assets, while depreciation applies to tangible assets. Another common issue is determining the useful life of intangible assets, which often requires professional judgment and market analysis.