Definition
Amortization of intangibles is a process that gradually reduces a company’s intangible assets’ value over time. It involves expensing out the cost of an intangible asset, like a patent or copyright, throughout the asset’s useful life. This method is used for accounting purposes to spread out an intangible asset’s cost as it is used, consumed, or depleted.
Phonetic
The phonetics for the phrase “Amortization of Intangibles” are:Amortization: uh-mawr-tuh-zey-shuhnof: uhv / ofIntangibles: in-tan-juh-buhls
Key Takeaways
Main Takeaways About Amortization of Intangibles
- Amortization Definition: Amortization of intangibles is the process of expensing intangible assets over their useful life to reflect their consumption, expiry, obsolescence, or other decline in value as a result of physical use or time. These assets include patents, trademarks, copyrights, goodwill, and brand recognition, among others.
- Determination of Amortization Period: The amortization period should reflect the useful life of the asset. If the asset has a finite life, it can be amortized over this time. However, if the life of the asset is uncertain, according to accounting standards, it should be amortized over no more than 40 years or a lesser period if justified.
- Financial Reporting: The amortization of intangible assets affects the financial statements of a company by reducing the value of assets on the balance sheet, decreasing earnings in the income statement due to the amortization expense, and potentially impacting cash flow depending on the type of asset and the associated tax laws.
Importance
The amortization of intangibles is an important concept in business and finance as it deals with the gradual charging to expense of the cost of an intangible asset over its useful life. Intangible assets are non-physical assets, like patents, trademarks, copyrights, goodwill, or software, which often represent a significant part of a company’s value. By amortizing these assets, companies can match the benefit received from the asset with the costs incurred to acquire it on their income statement, thus providing a more accurate picture of the company’s financial health over time. Without this amortization, the costs would be recognized immediately at the time of purchase, potentially distorting reported profit levels. Therefore, understanding this term is crucial for financial analysis and decision-making.
Explanation
The purpose of the amortization of intangibles in business finance is to gradually reduce the value of intangible assets over a specific period of time. Intangible assets are non-physical assets that hold value, such as patents, trademarks, copyrights, goodwill, and brand recognition. Like their tangible counterparts, these intangible assets contribute to the earning power of a company, but unlike tangible assets, their value cannot be easily measured. Therefore, amortization is a systematic method used to consistently reduce their initially recorded cost in a reasonable and logical manner. This method of cost reduction is used until the asset’s cost is reduced to zero or its salvage value.Amortization of intangibles is primarily used for accounting and tax purposes. It helps businesses to match the cost of the intangible asset to the revenues that the asset generates and provides a more accurate picture of a company’s financial health. For instance, if a company acquires a patent for a certain technology, the cost of the patent is not recognized as an expense immediately. Instead, it is gradually written off over the patent’s useful life. This consistent reduction in the value of the asset aids in distributing the cost over the applicable periods, providing a more realistic view of the company’s income and financial status.
Examples
1. **Brands and Trademarks**: When a company purchases another company, one significant cost may involve acquiring black-and-white rights to a famous brand name or logo. For instance, when Facebook acquired WhatsApp for $19 billion in 2014, a large portion of this sum was attributed to the app’s substantial daily user base and popularity – intangible assets like the WhatsApp brand name and user relationships. In this event, Facebook would have to amortize the value of these intangible assets over a reasonable lifespan.2. **Patents and Technologies**: Assume a pharmaceutical company purchases a patent for a new medicine from another business. The cost incurred to purchase this patent is not immediately expended in the year of acquisition but rather is slowly expensed over the life of the patent, which is the process of amortization. For example, when Gilead Sciences acquired Pharmasset and their revolutionary Hepatitis C drug Sofosbuvir, they had to amortize the value of the patents acquired over expected useful life.3. **Goodwill**: When a liquor company buys a rival firm, part of the purchase price might be assigned to a category known as “goodwill.” This intangible asset might encompass value for factors like a loyal customer base, robust distribution network, or exceptional employee relations. For instance, when Disney bought Pixar for $7.4 billion in 2006, it was not just paying for Pixar’s then-current movie library, but for the company’s potential to create new hits in the future. The goodwill from this deal would need to be amortized over a certain number of years.
Frequently Asked Questions(FAQ)
What is the meaning of Amortization of Intangibles?
Amortization of intangibles refers to the gradual reduction of the value of an intangible asset over a certain period of time. This can include assets such as patents, trademarks, copyrights, or goodwill. These assets may lose their value as they become obsolete, expire, or in the case of goodwill, when the benefitted business advantage diminishes.
How does Amortization of Intangibles work?
Amortization of Intangibles works by distributing the cost of intangible assets over their useful lifespan. It is a systematic and non-reversible process. For example, if a company purchases a patent for $100,000 and has a useful life of 10 years, the company will amortize $10,000 every year.
Is Amortization of Intangibles similar to depreciation?
Yes, the concept of amortization of intangibles is similar to depreciation, but the major difference is that depreciation is used for tangible assets, while amortization is used for intangible assets.
How does Amortization of Intangibles affect a company’s financial statements?
Amortization of intangibles is recorded as an expense on a company’s income statement, reducing the company’s net income. On the balance sheet, the accumulated amount of amortization is subtracted from the original cost of the intangible asset in each accounting period.
Where is Amortization of Intangibles reported on the financial statement?
The amortization of intangibles is reported on the income statement under operating expenses. On the balance sheet, it reduces the carrying value of the intangible asset from its original cost.
How is the period of Amortization of Intangibles determined?
The period over which an intangible asset is amortized is typically determined by the estimated useful life of the asset, or the legal life of the asset, whichever is shorter. This is subject to rules set out by accounting standards and may vary by jurisdiction.
What happens if an intangible asset has infinite life?
If an intangible asset has an indefinite lifespan (such as certain brands or trademarks), then they are not usually amortized. Instead, they are tested annually for any possible impairment loss, which if found, would be recorded as an expense.
Related Finance Terms
- Intangible Assets
- Amortization Schedule
- Goodwill
- Non-deductible Expenses
- Impairment Loss
Sources for More Information
