Intangibles amortization definition
/What is an Intangible Asset?
Intangible assets are assets with no physical substance. Examples of intangible assets are patents, copyrights, and customer lists. They can be recognized in your accounting records if you have purchased them from a third party, or through a business acquisition. Businesses that have invested large amounts to establish brands may find that the value of their intangible assets greatly exceeds the value of their physical assets.
What is Intangibles Amortization?
The amortization of intangibles involves the consistent reduction in the recorded value of an intangible asset over its projected life. Amortization refers to the write-off of an asset over its expected period of use (useful life). Intangible assets do not have physical substance. Examples of intangible assets are copyrights, customer lists, government licenses, non-competition agreements related to an acquisition, patents, taxi licenses, and trademarks.
Intangible assets are usually purchased from other entities, or are recorded as a result of the acquisition of another entity, and so are much less frequently recorded in the accounting records than tangible fixed assets. However, intangible assets recorded as part of acquisitions are frequently of considerable size, so the amortization method and useful life associated with them can have a profound (and negative) impact on the reported profits of the acquiring entity. It is non uncommon for an acquiring entity to experience years of losses as it gradually writes off the intangible assets associated with an acquisition.
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Once amortization begins, it is rarely changed unless there is evidence that the value of the intangible asset being amortized has become impaired. If so, there is an immediate write-down in the remaining value of the intangible asset in the amount of the impairment. At that point, you must evaluate whether the useful life of the asset has also changed, and modify the amortization calculation to incorporate not only the new useful life, but also the remaining (reduced) carrying amount of the asset. These changes should be well-documented, since they will be examined by the company's auditors as part of the annual audit.
Example of Intangibles Amortization
Here are several examples of how to amortize intangibles, based on differing assumptions:
Downgrade in value of an intangible asset. ABC International acquires another company, and as a result recognizes a customer list asset in the amount of $1,000,000. ABC elects to amortize this intangible asset over the next five years at a rate of $200,000 per year. After one year, the carrying amount of the asset has been reduced to $800,000, but ABC now estimates that the asset has a market value of only $300,000 and a remaining useful life of just two years. Accordingly, ABC incurs a $500,000 impairment charge to write down the value of the asset to $300,000, and then re-sets the associated amortization to be $150,000 in each of the next two years. After that time, the customer list asset will have a carrying amount of zero in the accounting records of ABC.
Planned resale of a patent. Armadillo Industries purchases a patent from a third party. The remaining life of the patent’s coverage of a key piece of production technology is eight years. Armadillo obtains a written commitment from a supplier to buy the patent in two years for 75% of the $100,000 price paid by Armadillo for the patent. Armadillo intends to sell the patent to the supplier in two years. Based on this information, Armadillo should amortize $25,000 of the purchase price over the two years that the company expects to retain ownership of the patent.
Amortization vs. Depreciation
Amortization relates to the ratable reduction in the recorded value of intangible assets, while depreciation is the ratable reduction in the recorded value of tangible assets. Amortization is usually conducted on a straight-line basis, while depreciation is more likely to be conducted on an accelerated basis.