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What is Amortization of Intangible Assets?
“Amortization of intangible assets” refers to the expensing of the cost of the intangible assets of a firm over the total lifetime of those assets. 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 over the period of its lifetime. The main difference between amortization and depreciation is that the prior is used in case of intangible assets and the other one is used in case of tangible assets.
Amortization Example #1
- Let us consider the case of a business organization, say Company ABC, which buys a patent for $ 15,000 for a period of 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.
Amortization 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 actually count up to 15 years.
- Let us consider that after a period of 5 years, the patent became worthless for the 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.
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Amortization Example # 3 (Additional costs)
- Another case is when there comes an excess of the expenses in the terms of the patent, maybe because of a break in terms by 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
- 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
- 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 in 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 easy as in the case of tangible assets. There are regulations, which group certain assets under the category of intangible assets and give them a 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 amount of an asset may not be recoverable.
For example, Goodwill. 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 amortized but is tested annually for impairment. Goodwill impairment for each reporting unit should be tested in a two-step process at least once a year.
Advantages of amortization of intangible assets
- 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 amortization of intangible assets is beneficial for the firm. Amortization 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 a minimum financial security.
This has been a guide to what is Amortization of Intangible Assets along with practical examples of Google Inc. Here we also discuss uses and advantages of amortization of intangible assets. You may also have a look at following articles on accounting –