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Amortization

Amortization refers to the annual fixed allocation of the cost of an intangible asset to expense on the income statement during the asset’s estimated useful life which is not to exceed forty years. The commonly used method for amortization is the straight-line method. Amortization is used for intangible assets like patents, copyrights, trademarks, etc. as opposed to depreciation which is used specifically for tangible assets. The purpose of amortizing an asset is to show the year-to-year reduction in its book value due especially to usage and/or obsolescence.

Patent
Costs incurred in researching and developing the patented product are not capitalized, but are treated as expenses.

Copyright
Like other intangible assets, the amortization of copyright is limited to a period of forty years.

Trade marks
All expenditures incurred in the registering and defending the trademark are amortized over its entire life.

Franchise
The cost of the franchise is amortized over its entire useful life limited to forty years.

For example, Sharp Arrow Technology spends one million dollars on a patent, and the company believes the patent can be useful for another five years. The company uses the straight-line method to calculate that $200,000 per year is to be written off as amortization expense for the next five years. The company would prepare either one of the following journal entries:

 

1. A contra-asset account for accumulated amortization

Date Accounts Folio Debit Credit
$ $
20XX
Dec 31 Amortization Expense 200,000
Accumulated Amortization - Patent 200,000
(Amortization of patent for year 20XX)

The amortization expense is written off to the income statement. The accumulated amortization account remains as a contra-asset account until the end of the patent’s useful life.

 

2. No contra-asset account for accumulated amortization

Date Accounts Folio Debit Credit



$ $
20XX



Dec 31 Amortization Expense
200,000

Patent

200,000

(Amortization of patent for year 20XX)


The yearly amortization expense is charged directly to the asset’s account reducing its yearly net book value.

Intangible assets with the exception of trademarks are shown at cost on the balance sheet. Trademarks are not normally shown on the balance sheet.

Last Updated (Tuesday, 14 September 2010 10:05)