Amortization of Intangible Assets
What Is Meant by the Amortization of Intangible Assets? – Definition
Amortization is the periodic allocation of the cost of an intangible asset over its useful life.
Amortization expense for intangible assets is based on the same concepts as depreciation. However, the process for selecting useful lives and allocation methods is more diffcult because of the inability to observe physical deterioration or obtain reliable market value estimates.
The service life should not exceed the legal life (if any). A shorter life should be applied if the asset will not be used for the entire period. When a legal life does not exist, as for goodwill, the selection of a life is potentially more flexible. Three approaches are used to amortize goodwill:
1. A life was estimated and used.
2. The full cost was written off at once.
3. No regular charge to amortization was taken; however, the goodwill was written down when it became apparent that its value had declined.
The first approach is required for all intangibles, even though some of them can be expected not to lose value while others will lose value only irregularly. The GAAP adopted its rule in order to produce a systematic pattern for the charges. The service life of any intangible should not exceed 40 years.
Selecting the Allocation Method for Amortization
The selection of an allocation method for computing annual amortization charges is theoretically subject to the same considerations that apply to depreciation. GAAP specifies that the straight-line approach “should be applied unless a company demonstrates that another systematic method is more appropriate”.
Commonly, the amortization expense entry records a credit to the asset account instead of a contra asset account. While this practice is inconsistent with the one used for depreciation, it is justifiable on the basis that little useful information would be provided by disclosing what proportion of the original cost remains to be consumed.