Amortization Of Intangibles
What is 'Amortization Of Intangibles'
Amortization of intangibles is the process of expensing the cost of an intangible asset over the projected life of the asset. The amortization process for accounting purposes may be different from the amount of amortization posted for tax purposes. Intangible assets are amortized into an expense account, and tangible assets are posted to expenses through depreciation.
BREAKING DOWN 'Amortization Of Intangibles'For tax purposes, the cost basis of an intangible asset is amortized over a specific number of years, regardless of the actual useful life of the asset. In the year the asset is acquired and sold, the amount of amortization deductible for tax purposes is prorated on a monthly basis, and intangible amortization is reported on IRS Form 4562.
Intangible assets are typically nonphysical and not easily assigned a value. According to Section 197 of the Internal Revenue Code, there are numerous qualifying intangible assets, but the most common are goodwill, the value of a worker's knowledge, trademarks, trade and franchise names, noncompetitive agreements related to business acquisitions, and a company's human capital.
Examples of Intellectual Property
Intellectual property (IP), such as patents and copyrights, is considered to be an intangible asset. When a parent company purchases a subsidiary company and pays more than the fair market value of the subsidiary's net assets, the amount over fair market value is posted to goodwill, which is an intangible asset. IP is posted as an asset on the firm's balance sheet when it is purchased, and IP cannot be internally generated by a company's own research and development (R&D) efforts.
The Differences Between Depreciation and Amortization
Businesses use assets to generate revenue and produce net income; over time, the cost of assets is gradually moved into an expense account. By recognizing an expense for the cost of the asset, the company is matching revenue with the expense incurred to generate the revenue. Tangible assets are expensed using depreciation, and intangible assets are expensed through amortization.
How to Account for Depreciation and Amortization
Assume, for example, that a carpenter uses a $32,000 truck to perform residential carpentry work, and that the truck has a useful life of eight years. The annual depreciation expense on a straight-line basis is the $32,000 cost basis divided by eight years, or $4,000 per year.
On the other hand, assume that a corporation pays $300,000 for a patent that allows the firm exclusive rights over the intellectual property for 30 years, and the firm's accounting department posts $10,000 of amortization expense each year for 30 years. Both the truck and the patent are used to generate revenue and profit over a particular number of years.