Definition: Amortization is the cost allocated to intangible assets over their useful lives. This process is similar to the depreciationprocess for fixed assets except alternative and accelerated expense methods are not normally allowed. The amortization process requires the use of the straight-line method unless the company can demonstrate how and why another preferred method is more appropriate.
What Does Amortization Expense Mean?
Intangible assets are non-physical assets that are used in the operations of a company. Some examples include patents, copyrights, and licenses. The assets are unique from physical fixed assets because they represent an idea, contract, or legal right instead of a physical piece of property.
These assets benefit the company for many future years, so it would be improper to expense them immediately when they are purchase. Instead, intangible assets are capitalized when purchased and reported on the balance sheet as a non-current asset. In order to agree with the matching principle, costs are allocated to these assets over the course of their useful life.
It’s important to remember that not all intangible assets have identifiable useful lives. Unlike physical assets, intangible assets don’t get worn out. They expire. Some intangibles don’t expire, however. Take a franchise license for example. It expires every year and can be renewed annually without a renewal limit. This situation creates an asset that never expires as long as the franchisee continues to perform in accordance with the contract and renews the license. In this case, the license is not amortized because it has an indefinite useful life.
Example
Air and Space is a company that develops technologies for aviation industry. It holds numerous patents and copyrights for its inventions and innovations. One patent was just issued this year that cost the company $10,000. Since patents are only good for 20 years, Air and Space would make a journal entry to record the amortization expense of $500 each year of its useful life by debiting amortization expense and crediting accumulated amortization.
