What to Do
The calculation for amortization is the same as the “straight-line” method of depreciation: the initial cost of the asset divided by its “useful life” (which may be an estimate).
Example:
Suppose the costs associated with gaining the copyright for a particular line are $7,000. The line is expected to sell for 15 years, so amortization is:
On the company balance sheet, this will appear as a cumulative figure, depending on the number of years since the asset was acquired.
The basic formula for amortization is very simple, and can be used to analyze items like write-offs, expenses paid in advance, depletion, and deferred charges. The rules about how these should be expressed in financial statements differ depending on the asset, and on the country where the business operates.
The concept of “useful life” is taken to mean how long an intangible asset remains of economic value. This is determined by factors like whether the asset is becoming out of date or wearing out, if there’s still a demand for it, other players in the marketplace, and any legal confines or contractual restrictions.
The following examples show how amortization might apply in particular contexts:
Copyright
Amortization is calculated either on the sum it cost to buy the copyright (or to develop it), together with costs sustained during the process—like salaries and resources. The period of amortization may be less than the legal length of the copyright, because the “useful life” of the copyright may be deemed to be much shorter.
Patents
Amortization applies to patents that have been bought, and patents developed within a company. In the latter case, legal fees associated with the application process will be included. Usually amortization is carried out for the legal length of the patent (unless its “useful life” is likely to be shorter).
Trademarks, trade names and brands
These intangibles are generally required to be written off within 40 years—but typically the period of amortization is shorter, because the fast-moving consumer environment tends to result in rapid depletion.
Setup costs
The costs of setting up an organization, company or partnership—like legal and accounting fees—are generally amortized over a period of five years.
Franchises
The cost of acquiring a franchise, including license fees, legal costs and expenses, can be amortized over its life (if the franchise is for a fixed term) or over a realistic period (if it is open ended). Annual costs incurred can be written off as they are made.
Covenants not to compete
These agreements restrain or prevent people from competing in a particular marketplace, for a specified period—which can be the period of amortization (unless “useful life” is likely to be shorter).
Easement costs
If a right of way is granted for a limited period, the costs associated with it can be amortized.
Other costs
Intangibles like the value of a company’s share in the market, or the customer base it represents, can be subject to amortization; as can intangibles in industrial contexts. For example, in the mining industry it could apply to the cost of development, drilling, controlling pollution and returning mined areas to their natural state.
What You Need to Know
- If an intangible asset has a clearly defined useful life, it may be more appropriate to apply depreciation rather than amortization—regulations will differ between countries, so it’s important to get advice from an expert.
- Sometimes, computer software may be amortized (depending on its application). Typically, such software is deemed to have a useful life of five years (or less if it will be demonstrably obsolete before that).
- A bought-in list of customers may be amortized if it has a limited useful life, or the customers are only retained for a limited time.
- Improvements to leasehold property are subject to depreciation in relation to income tax. But in relation to financial reporting, they may be amortized—either for the length of the lease or for the useful life of the improvements (whichever is the shorter).
- There are many free amortization calculators on the Internet enabling borrowers to compute the total cost of a loan, and the amount they’ll repay each month.
Where to Learn More
Web Sites:
Financial Accounting Standards Board: www.fasb.org
U.S. Copyright Office: www.copyright.gov
U.S. Patent and Trademark Office: www.uspto.gov
