Amortization of Intangible Assets

Image: Moneybestpal.com

Amortization of intangible assets is the process through which the cost of an asset of this type is gradually incurred or wiped off. Non-physical assets including as trademarks, customer lists, goodwill, patents, etc. are examples of intangible assets that can be given a monetary value.

Classification of Intangible Assets

Intangible assets can be broadly classified into two categories: definite life and indefinite life.

Definite-life intangible assets refer to assets with a finite life. Suppose you had a ten-year license to manufacture a specific product. In this case, the asset is assigned an identified contract life of ten years. Asset amortization usually applies to these kinds of intangible assets. They might also depreciate over time, at which point the business will record an impairment charge and lower the asset's value on its balance sheet.

Indefinite-life intangible assets refer to assets whose life is unknown at inception. They could produce or contribute to income indefinitely, such as broadcasting rights that the owner could easily renew on an ongoing basis. Another example of an intangible asset with an unlimited life span is goodwill. Instead of typically being amortized, these intangible assets are typically subject to annual impairment testing.

Determination of Life

The International Accounting Standards Board’s IAS 38 sets out rules on how to determine the life of an intangible asset, such as:

• Expected usage: the amount of time that the asset is anticipated to benefit the company. Another factor that may permit the usage of the intangible asset is the term of the contract. Copyright, for instance, will have a 50-year legal life but just 10 years of practical usage. So, a useful life of ten years is the suitable one for amortization.
• Product life cycle: Certain intangibles could be product-specific and shouldn't last any longer than the things they are associated with.
• Technical obsolescence: Any intangible asset related to a product that is now regarded to be obsolete technically should be viewed as impaired and amortized accordingly.

Amortization Methods

There are six amortization methods that can be used for accounting purposes:

• Straight line: The cost of the intangible asset is evenly allocated over its useful life.
• Declining balance: The cost of the intangible asset is allocated over its useful life using a constant rate of depreciation.
• Annuity: The cost of the intangible asset is allocated over its useful life using a constant amount of depreciation.
• Bullet: The cost of the intangible asset is fully allocated at the end of its useful life.
• Balloon: The cost of the intangible asset is partially allocated at the end of its useful life.
• Negative amortization: The cost of the intangible asset is not fully allocated over its useful life, resulting in an increase in its carrying value.

The most common method for amortizing intangible assets is the straight-line method, as it is simple and reflects a consistent pattern of consumption.

Tax Treatment

Regardless of the asset's real useful life (because the majority of intangibles don't have a fixed useful life), the cost basis of an intangible asset is amortized over a certain number of years for tax reasons. If an asset falls under Section 197, the Internal Revenue Service (IRS) permits amortization over a 15-year period. Patents, goodwill, trademarks, and trade and franchise names are a few examples of these Section 197 intangible assets.

However, not all intangibles are amortized over the IRS-specified 15-year timeframe. There are several exceptions, including software bought in a transaction that is easily accessible to the general public, covered by a nonexclusive license, and hasn't undergone significant modification. The amortization of intangibles is governed by Section 167 in certain circumstances and a few more.