Amortization of Intangibles
Candlefocus EditorUnder US GAAP and IFRS, an intangible asset is considered to have an indefinite useful life and, therefore, cannot be amortized. Instead, the asset is tested for impairment annually. This means that a business should assess the fair value of the asset every year to determine whether its carrying value should be reduced to fair value due to impairment. This is a very subjective process and can often be challenging to estimate accurately.
In contrast, under US tax law, some assets with an indefinite useful life, such as goodwill and certain trademarks and copyrights, can be amortized. These assets must be amortized over a 15 year period, with certain limitations.
The amortization of intangible assets generally follows one of six different amortization methods: straight line, declining balance, annuity, bullet, balloon, and negative amortization.
Straight line amortization is the most common method. In its simplest form, straight line amortization divides the initial value of the intangible asset into equal portions that are deducted from the assets recorded value on the balance sheet each year to arrive at the residual value of the asset. This method also applies to depreciation of tangible assets.
The declining balance amortization is based on a percentage of the initial value of the asset that is reduced each year. There are typically two types of declining balance methods—a declining balance method with no switch (at the end of the period the asset is fully written off) and the declining balance with a switch method (at the end of the period the remaining balance is switched over to the straight line method).
The annuity amortization method derives the same results as the straight line amortization method, but it uses a formula to compute the annual amortization from an annuity present value. This approach is useful when the life of the asset is characterized by an increasing or decreasing rate of amortization over time.
The bullet amortization is a single sum payment amortization method. This method is used when the payment is based on a lump-sum amount paid at the end of the period.
The balloon amortization is a modified bullet method whereby the asset is fully amortized by the end of the period, but the expenses include an increased payment at the beginning of the period and decreased payments towards the end.
The negative amortization amortization method is very different from all of the other methods. This method implies that expenses occur and the asset is not being decreased by an amount equal to what is being expensed. The difference is accumulated in an "accumulated amortization" account and the net carrying value of the asset is increased.
In conclusion, amortization of intangibles is the process by which the cost of an intangible asset is incrementally expensed or written off over time. There are six different amortization methods that can be chosen to allocate the cost of the intangible asset over its period of benefit to a business. Generally, for US tax purposes, intangible assets must be amortized over a 15 year period. It is important to have an accurate estimate of the useful life of the asset when choosing the most applicable amortization method.