In this article, we will explore in detail the types of assets that are amortized, the differences between tangible and intangible assets, the accounting treatment for each, and the criteria that determine whether an asset qualifies for amortization.
Understanding Asset Types: Tangible vs. Intangible
To comprehend which assets are amortized, it is vital first to distinguish between tangible and intangible assets, as the treatment for each differs significantly.
What Are Tangible Assets?
Tangible assets are physical items that have a measurable useful life and can be touched or seen. Examples include:
- Machinery
- Buildings
- Vehicles
- Equipment
- Land (although land is not depreciated)
Tangible assets are typically depreciated over their useful lives, not amortized, because they have physical substance.
What Are Intangible Assets?
Intangible assets are non-physical assets that provide long-term value to a company. Examples include:
- Patents
- Trademarks
- Copyrights
- Goodwill
- Franchise rights
- Licenses
- Software (depending on circumstances)
Intangible assets are generally amortized over their estimated useful lives, as they lack physical substance but still provide economic benefits over time.
Assets That Are Amortized
The core focus of this discussion is on intangible assets, as they are the primary category of assets that undergo amortization.
Intangible Assets Subject to Amortization
Not all intangible assets are amortized; some are subject to impairment testing instead. However, the typical intangible assets that are amortized include:
1. Patents
Patents grant exclusive rights to an invention for a limited period, usually 20 years from the filing date. The cost of acquiring a patent is amortized over its estimated useful life, which can be the patent's legal life or shorter if technological obsolescence occurs earlier.
2. Copyrights
Copyrights provide exclusive rights to creative works, such as books, music, or software, generally lasting for the life of the author plus 70 years. The amortization period is usually the legal or useful life, whichever is shorter.
3. Trademarks and Service Marks
Trademarks can be indefinite in life if they are renewed regularly and actively used. However, if a trademark has a finite useful life or is purchased outright, it is amortized over that period.
4. Licenses and Franchise Rights
Licenses granted by government agencies or other entities often have a finite term (e.g., 10 years) and are amortized over that period.
5. Software (Purchased or Internally Developed)
Software is amortized if it is purchased or if development costs are capitalized. The amortization period depends on the expected useful life, often 3 to 5 years.
6. Customer Lists and Goodwill (if acquired)
Goodwill is not amortized but tested annually for impairment. However, other intangible assets like customer lists, when acquired separately, are amortized over their estimated useful lives.
Note: Internally developed trademarks and goodwill are generally not amortized but are subject to impairment testing.
Assets That Are Not Amortized
While many intangible assets are amortized, some are not and require different accounting treatment.
Goodwill
Goodwill arises when a company acquires another business for more than the fair value of its net identifiable assets. According to accounting standards (e.g., IFRS and GAAP), goodwill is not amortized but tested annually for impairment.
Indefinite-Lived Intangible Assets
Assets like certain trademarks or brand names that are expected to generate benefits indefinitely are classified as indefinite-lived and are not amortized. Instead, they undergo impairment testing.
Criteria for Amortization
For an asset to be amortized, it must meet specific criteria:
- The asset must be identifiable and intangible.
- The asset must have a finite useful life—meaning there is a foreseeable period during which the asset provides economic benefits.
- The cost of the asset must be reliably measurable.
If these criteria are met, the asset is amortized over its estimated useful life, which should reflect the period over which the asset is expected to generate cash flows.
Accounting Treatment of Amortization
The process of amortization involves systematically allocating the cost of an intangible asset over its useful life. The typical journal entry to record amortization expense is:
- Debit: Amortization Expense
- Credit: Accumulated Amortization
This expense appears on the income statement, while the accumulated amortization reduces the book value of the intangible asset on the balance sheet.
Key points:
- Amortization is usually calculated on a straight-line basis, but other methods can be used if they better reflect the pattern of economic benefits.
- The amortization period should be reviewed regularly, and any changes should be accounted for prospectively.
Examples of Amortized Assets in Practice
To clarify, here are some practical examples:
- A company purchases a patent for $100,000 with an estimated useful life of 10 years. Each year, it records an amortization expense of $10,000.
- A franchise agreement with a 15-year contractual term is capitalized and amortized over that period.
- Software purchased for $50,000 with an estimated useful life of 5 years is amortized at $10,000 annually.
Implications for Financial Reporting and Taxation
The treatment of amortized assets affects both financial statements and tax filings:
- Financial Statements: Amortization expenses reduce net income but also reduce the carrying amount of intangible assets on the balance sheet.
- Taxation: Many tax jurisdictions allow amortization or depreciation deductions for intangible assets, which can reduce taxable income.
However, specific rules and periods vary by jurisdiction and asset type.
Summary of Assets That Are Amortized
| Asset Type | Typically Amortized | Notes |
|-----------------------------------|---------------------|----------------------------------------------------|
| Patents | Yes | Over legal life or estimated useful life |
| Copyrights | Yes | Usually over legal or estimated useful life |
| Trademarks/Service Marks | Usually no (if indefinite) | Finite useful life if purchased or limited duration |
| Licenses and Franchise Rights | Yes | Over license or franchise period |
| Purchased Software | Yes | Usually 3-5 years depending on use |
| Internally Developed Software | Usually no (if developed internally) | Capitalized costs amortized if applicable |
| Customer Lists | Yes | Over estimated useful life |
| Goodwill | No | Impairment tested, not amortized |
In conclusion, among various assets, intangible assets with finite useful lives—such as patents, copyrights, licenses, franchise rights, and purchased software—are typically amortized. This systematic allocation aligns with the matching principle in accounting, ensuring expenses are recognized in the periods during which the assets provide economic benefits. Proper understanding and application of amortization rules are vital for accurate financial reporting, tax compliance, and effective asset management.
Frequently Asked Questions
Which types of assets are typically amortized?
Intangible assets such as patents, trademarks, copyrights, and software are typically amortized over their useful lives.
Is a patent considered an asset that is amortized?
Yes, patents are intangible assets that are amortized over their estimated useful life.
Are copyrights subject to amortization?
Yes, copyrights are intangible assets that are amortized over their legal or useful life.
Which of the following assets are amortized: land, equipment, or software?
Software is amortized, whereas land and equipment are generally not amortized but depreciated.
Does the amortization apply to goodwill?
No, goodwill is not amortized; it is tested for impairment annually instead.
How is the amortization period determined for intangible assets?
The amortization period is based on the estimated useful life of the intangible asset, which is determined by management or legal factors.
Can software development costs be amortized?
Yes, capitalized software development costs are amortized over their estimated useful life.
Are customer lists amortized as assets?
Yes, if purchased or developed internally, customer lists are considered intangible assets and are amortized.
Is a leasehold improvement asset amortized?
Yes, leasehold improvements are amortized over the shorter of the lease term or the useful life of the improvements.
Which of the following assets are not amortized: trademarks, land, or patents?
Land is not amortized; trademarks and patents are intangible assets that are amortized over their useful lives.
