Amortization of Intangible Assets: Definition

Amortization is the periodic allocation of the cost of an intangible asset over its useful life.

Amortization of Intangible Assets: Explanation

Amortization expense for intangible assets is based on the same concepts as depreciation.

However, the process for determining useful lives and selecting allocation methods is more difficult compared to the case of depreciation. This is due to the inability to observe physical deterioration or obtain reliable market value estimates.

The service life of an asset should not exceed its 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 service 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 intangible assets, even though some can be expected not to lose value while others will lose value only irregularly.

GAAP adopts specific rules to produce a systematic pattern for the charges. In particular, the service life of any intangible should not exceed 40 years.

Selecting an 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 the proportion of the original cost that remains to be consumed.

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