Besides being a great word to totally dominate Words With Friends, amortization is a useful concept for any business owner to know about—especially those who work with a lot of intangible assets like trademarks and patents. If you have a presence on the web, you probably have at least one intangible asset, so it’s worth reading on.
Amortization is related to depreciation in that it allows you to account for the cost of an asset over time. But while depreciation deals with tangible assets, amortization deals with intangible assets.
What’s an Intangible Asset?
Intangible assets are things that provide ongoing value to your business but that aren’t physical objects. Examples of intangible assets that small business owners may commonly have included:
- Customer lists
- Internet domain names
- Licensing agreements
- Service contracts
- Trade secrets (like a secret recipe)
Created vs. Acquired Intangible Assets
Businesses can either create intangible assets or acquire them. For example, you may spend time and resources slowly building up a customer list over time, or you may purchase a customer list from another company.
For acquired assets, you can amortize the acquisition cost. If you purchase a trade secret off another company to use in your business, the cost of that can be amortized.
For created intangible assets, it can be a little more complex, but for most instances that small business owners deal with—like paying for trademarks and copyrights to protect your intellectual property, purchasing a domain name, or applying for a patent—the costs of creating that asset can be amortized over time. If you’re dealing with a different intangible asset and aren’t sure whether you can amortize it, it’s probably worth chatting with an accountant.
Amortization of an Intangible Asset
When amortizing an intangible asset, the straight-line method is most commonly used, where you spread the cost of the asset over the number of years you expect it to provide value.
To figure out the lifespan of an intangible asset, you use either the legal lifespan of the asset, or the expected useful lifespan (whichever is shorter). For example, if you are amortizing the cost of a $20,000 patent, the patent may be legally viable for 30 years, but if the technology will only be useful for 10 before being old news, you would amortize it over 10 years. Each year, the following entry would go in your books (with accumulated amortization adding up year after year):
Amortization Expense 2,000
Accumulated Amortization 2,000
What if you’re amortizing something with indefinite value? For example, let’s say you spent $5,000 to purchase your web address from a private owner. How do you determine its lifespan when you plan to use it, well, forever? In situations like this, it’s probably worth checking with an accountant—the IRS may have guidelines for that specific situation. (For this specific situation, the IRS has stated that a domain is supposed to be amortized over a 15-year period.)
Abridged by Amy
- Amortization is similar to depreciation, but focuses on the costs of intangible assets. It allows businesses to account for the cost of intangible assets over time.
- Intangible assets are non-physical assets that are expected to provide value to a business for more than a year.
- The most common way to amortize is to divide the cost of an intangible asset over the number of years you expect it to provide value to your business.