What is the Amortization of Intangible Assets?
Amortization of Intangible Assets refers to the method under which the cost of the different intangible assets of the company (assets which do not have any physical existence, cannot be felt and touched like trademark, goodwill, patents etc) are expensed over the specific period of time.
In simple words, it refers to expensing the cost of the intangible assets of a firmIntangible Assets Of A FirmIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. over their total lifetime. The term “intangible assets” refers to those assets, which are not physical in nature. These can be assets such as trademarks, copyrights, patents, etc.
Amortization of intangible assets is similar to depreciation, which is the spreading out of the cost of the firm’s assets for its lifetime. The main difference between amortization and depreciation is that the prior is used in the case of intangible assets, and the other one is used in the case of tangible assets.
- Let us consider the case of a business organization, say Company ABC, which buys a patent for $ 15,000 for 15 years. So the company can utilize the patent for the benefit of it for 15 years, and the total value of the patent, which is $ 15,000, is amortized over the time of 15 years.
- So the Company ABC will amortize an expense of $ 1,000 each year and deduct that value from the value of the patent on its balance sheet every year.
- In this manner, the total value of the patent is expensed by the method of amortization during the patent’s useful life.
Example # 2 (Patent becomes worthless after some years)
- There can be cases where the useful life of the patent owned for 15 years does not count up to 15 years.
- Let us consider that after 5 years, the patent became worthless for Company ABC. So the useful life of the intangible asset, namely the patent, is reduced from 15 years to 5 years.
- So, for only 5 years, the cost of the asset can be amortized, and it is expensed by only $ 1,000 each year.
- In this case, the remaining cost that is $ 10,000, which is unamortized, is to be expensed together, and the value of the patent is reduced to $ 0 on the firm’s balance sheet.
Example # 3 (Additional costs)
- Another case is when there comes an excess of the expenses in terms of the patent, maybe because of a break in terms of a third party. In such a case, the firm needs to hire a lawyer.
- So let us say the firm hired a lawyer, who charged the company with a cost of $ 10,000 and successfully defended the patent. In such a case, the amount spent for the lawyer, which is $ 10,000, is added to the value of the patent and is amortized over the remaining useful life of the patent.
Google’s Amortization of Intangible Assets
source: Google 10K
Patents and developed technology
- Net Carrying Value = $2,220 mn
- The remaining useful life is 3.8 years.
- Amortized expense related to Patents and developed technology in 2018 will be = $2,220/3.8 = $584.21 mn
- Net Carrying Value = $96 mn
- The remaining useful life is 1.7 years.
- Amortized expense related to Patents and developed technology in 2018 will be = $96/1.4 = $68.57 mn
Patents and developed technology
- Net Carrying Value = $376 mn
- Remaining Useful life is 4.6 years;
- Amortized expense related to Patents and developed technology in 2018 will be = $376/4.6 = $81.7 mn
Uses of Amortization of Intangible Assets
Amortization of intangible assets can be used for two purposes, the first one being for accounting purposes and the second one being for tax deferment purposes.
The amortization methods used for these two purposes are different from each other. When used in case of tax purposes, the actual lifespan of the assets is not considered, and only the base cost is amortized over a specific number of years. Intangible assets are not physical in nature, and finding an actual value for them is not as easy as in the case of tangible assets. There are regulations, which group certain assets under the category of intangible assets and give them particular value.
Amortization of Intangibles Assets – Infinite useful life
Intangible assets without a finite useful life, i.e., with an indefinite useful life, are not amortized but are reviewed for impairment whenever changes in events or circumstances indicate that the carrying amountThe Carrying AmountThe carrying amount or book value of asset is the cost of tangible, intangible assets or liability recorded in the financial statements, net of accumulated depreciation or any impairments or repayments. Accordingly, the carrying amount may differ from the market value of assets. of an asset may not be recoverable.
For example, GoodwillGoodwillIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company's net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company's net identifiable assets from the total purchase price.. Below is the Google Inc purchase price allocation of all the acquisitions taken from its 10-K Report.
Under U.S. GAAP SFAS 142, goodwill is not amortizedGoodwill Is Not AmortizedGoodwill amortization refers to the process in which the cost of the goodwill of the company is expensed over a specific period of the time i.e., there is a reduction in the value of the goodwill of the company by the way of recording of the periodic amortization charge in the books of accounts. but is tested annually for impairment. Goodwill impairmentGoodwill ImpairmentGoodwill impairment is the process of writing off the accounting charge amounting to the excess of the acquired asset's book value as recorded in the financial statements over its fair value. A higher impairment charge reflects the company's irrational investment decisions. for each reporting unit should be tested in a two-step process at least once a year.
- Primarily, the use of amortization in firms is to reduce tax burdens. As long as an asset is in use, you can reduce the tax to be paid.
- It helps the firm to show a higher value of assets and more income on the firm’s financial statements.
The use of the amortization of intangible assets is beneficial for the firm. It helps in assessing the value of the amortized asset with ease. At the same time, it helps in assessing the benefits of owning it. It, moreover, helps the firm by reducing the tax burden they possess. The amortization of capital expenses helps the firm to always possess minimum financial security.
Amortization of Intangible Assets Video
This article has been a guide to what is Amortization of Intangible Assets and its definition. Here we discuss how to calculate amortization along with practical examples of Google Inc. Here we also discuss the uses and advantages of the amortization of intangible assets. You may also have a look at following articles on accounting –