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Amortization

Overview Description

In simple terms, amortization is the process of accounting for an amount over a given period of time. Tax law refers to amortization as the cost recovery system for intangible properties. Amortization can therefore mean the continuing elimination of a liability in regular gradual payments over a given period of time. In other words, it is writing off an insubstantial asset investment over a period of time, usually over the projected period of time of the asset’s useful life.

Amortization of intangibles

An intangible asset is typically anything non physical in nature and hard to assign an actual value. Qualified non-tangible goods include noncompetitive trade agreements correlated to a company’s human capital and business acquisition, goodwill, trademarks, the value of a worker’s expertise, trade and franchise names etc. Amortization of intangibles is the practice of deducting the cost of an investment in a qualifying non-tangible asset over the estimated life of the asset, usually a 15-year period, regardless of the actual useful life of the asset.

Amortization works by measuring the consumption of the value of the intangible asset. This is therefore to say that amortization can also mean the paying off of amount overdue in regular installments over the specified period of time.

Note that the value paid should be sufficient to cover both the principal amount invested and the interest earned. For instance, company A spent $30 million on medical supplies, and the patent on the supplies lasts 15 years, thus, $2 million would be recorded every year for the next 15 years as an amortization expense.

In theory, amortization is supposed to deduct systematically from the basis over an asset’s projected valuable economic life, in order to reflect its consumption, obsolescence, expiration or any other decline in value resulting from its use, or due to passage of time, but a complete match of income and deductions is never achieved in most cases due to policy reasons.

Amortization and depreciation

Depreciation is an equivalent theory for tangible assets. It is not surprising to find depreciation and amortization being used interchangeably. This is because all methodologies for allotting amortization to each tax period are in overall the same as methodologies for depreciation. In principle, it is an incorrect application since depreciation refers to tangible assets while amortization refers to intangible assets.

That not withstanding, a lot intangible assets like goodwill may be considered to have an indefinite valuable economic life and are thus not subject to amortization. Typically, an intangible property or asset should be one held for use either in business, trade or for the production of profits.

Aims of amortization

In modern economy, amortization is aimed at repaying investor’s expenses, righting investment policies for the reason of dealing with national tasks of structural expansion of the economy, reinstating the structure of economic balances under inflation, restoring capital taking into account its length of life, and buttressing scientific technical and technological production among many others.

Amortization is calculated using contemporary financial calculators, amortization tables and charts, or spreadsheet software packages like Ms Excel.

Tags: deduction, Income, law, policy, tax

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