What Is the Amortization of Intangibles?

What Is the Amortization of Intangibles?

I'm going to explain amortization of intangibles directly to you—it's the process where you expense the cost of an intangible asset over its projected life for tax or accounting purposes. You know, things like patents and trademarks get amortized into an expense account simply called amortization.

Tangible assets, on the other hand, are written off through depreciation. Remember, the amortization for corporate accounting might not match what's used for taxes.

Key Takeaways

You need to grasp that amortization of intangible assets means incrementally expensing or writing off their cost over time. It applies to nonphysical assets, while depreciation handles physical ones. Intangible assets cover intellectual property like patents, goodwill, and trademarks. For taxes, most are amortized over 15 years. In accounting, you have six methods: straight-line, declining balance, annuity, bullet, balloon, and negative amortization.

Understanding the Amortization of Intangibles

For taxes, you amortize the cost basis of an intangible over a set number of years, ignoring the actual useful life since most don't have one. The IRS lets you do this over 15 years if it's under Section 197.

Intangible assets are nonphysical but hold economic value. Intellectual property falls into this, and most is under Section 197—think patents, goodwill, trademarks, trade names, and franchises.

Not everything gets the 15-year treatment, though. Exclusions exist, like software that's publicly available, nonexclusive, and unmodified—those go under Section 167 for amortization.

Under GAAP, you amortize intangibles over time to match the asset's cost with the revenues it generates in the same period.

Special Considerations

When a parent company buys a subsidiary and pays over the fair market value of its net assets, that excess goes to goodwill, an intangible asset. If you purchase IP, it starts as an asset on the balance sheet.

IP can also come from your own R&D efforts—like winning a patent for a new process that adds value to your company, which you must record properly.

In both cases, amortization lets you write off part of that value each year on a schedule.

Amortization vs. Depreciation

Assets generate revenue and income for businesses. Over time, you move their costs to an expense account as their useful life decreases. This complies with GAAP by matching revenue to the expenses that produce it.

You use depreciation for tangible assets and amortization for intangibles. Depreciation often includes a salvage value—the amount you could sell the asset for at life's end. Amortization doesn't consider salvage value.

You report intangible amortization to the IRS on Form 4562.

Types of Amortization

For financial statements, you can pick from six amortization methods: straight-line, declining balance, annuity, bullet, balloon, and negative amortization. For depreciation of physical assets in accounting, there are four: straight-line, declining balance, sum-of-the-years’ digits, and units of production.

For taxes, the IRS allows two for intangibles: straight-line or the income forecast method, which you can use for things like films, recordings, copyrights, books, or patents. For physical assets, it's only MACRS for depreciation.

Example of Amortization

Say a construction company buys a $32,000 truck with an eight-year life and $4,000 salvage value. Using straight-line depreciation, the annual expense is ($32,000 - $4,000) divided by 8, which is $3,500.

Now, if a corporation pays $300,000 for a 30-year patent, you post $10,000 amortization expense each year. The truck uses depreciation as a physical asset, while the patent uses amortization as intangible—both tie to revenue generation over years.

How Do You Define Amortization of Intangibles?

Amortization of intangibles is expensing costs of assets like patents and trademarks over their life for tax or accounting. We just call it amortization, and it's expensed into an amortization account.

How Do You Compute Amortization of Intangibles?

You calculate it several ways, but straight-line is common: expense the asset over time by dividing the cost minus salvage or book value by the years of use.

Where Do You Find Amortization of Intangibles on Financial Statements?

It shows on the profit and loss statement under expenses and on the balance sheet under non-current assets.

The Bottom Line

Amortization of intangibles is expensing an intangible asset's cost over its projected life for tax or accounting. These assets, like goodwill, patents, and trademarks, go into an amortization expense account.