Assets are resources owned or controlled by a company or business that bring future economic inflows. There are various types of assets that companies use in daily operations to generate revenues. Among these are fixed assets, which they use in the long run to generate revenues. These assets can be either tangible or intangible.
What is the Amortization Expenses?
Amortization, in accounting, refers to the technique used by companies to lower the carrying value of either an intangible asset. Amortization is similar to depreciation as companies use it to decrease their book value or spread it out over a period of time. Amortization, therefore, helps companies comply with the matching principle in accounting.
Sometimes, amortization also refers to the reduction in the value of a loan. In this case, amortization is similar to its use for assets. Companies use amortization to spread out a loan over time.
To do so, companies may use amortization schedules that lenders, such as financial institutions, provide to the borrower, the company, based on the maturity date. The schedule will consist of both interest and principal elements for the company to record.
Overall, companies use amortization to write down the balance of intangible assets and loans. Similarly, it allows them to spread out those balances over a period of time, allowing for revenues to match the related expense.
For intangible assets, companies use the asset’s useful life to divide its cost over time, while for loans, they use to number of periods for payments.
Journal entry
The journal entry for amortization differs based on whether companies are considering an intangible asset or a loan.
Intangible assets
For companies to record amortization expenses, it is necessary to have some specific amounts. Firstly, companies must have the asset’s cost or its carrying value recognized based on the related standards.
Similarly, they need to establish a useful life for the intangible asset based on judgment. After that, companies will need to decide on amortization, similar to depreciation, either straight-line or reducing balance method.
After calculating the amortization for the intangible asset based on the method used, companies can record the expense using the following journal entry.
| Dr | Amortization expense | x |
| Cr | Accumulated amortization | x |
The accounting treatment for the amortization of intangible assets is similar to depreciation for tangible assets. The amortization expense increases the overall expenses of the company for the accounting period. On the other hand, the accumulated amortization results in a decrease in the intangible asset value in the Balance Sheet.
Loans
As stated above, most financial institutions provide companies with loan repayment schedules with the breakup of periodic payments split into principal and interest payments.
Companies can use the schedules to determine the value they should record. However, they can also calculate the value based on the agreement made with the related financial institution.
Once companies determine the principal and interest payment values, they can use the following journal entry to record amortization expenses for loans.
| Dr | Interest expense | x |
| Dr | Loan | x |
| Cr | Cash/Bank | x |
The interest expense here results in an increase in a company’s overall expenses in the Income Statement. The debit to the loan account, with the principal value, reduces the value of the loan in the Balance Sheet.
Lastly, the credit to the cash or bank account is the amount of repayment made by the company. It decreases the cash balances of the company on the Balance Sheet.
Example
A company, ABC Co., purchased an intangible asset of $10,000. It recorded the asset in its accounts at its cost. ABC Co. also determined the useful life of the intangible asset to be five years. The company uses a straight-line amortization method.
At the end of the year, ABC Co. must record the amortization expense for the asset. The amortization expense for the asset will be $2,000 ($10,000 / 5 years) each year.
To record the amortization expense, ABC Co. uses the following double entry.
| Dr | Amortization expense | $2,000 |
| Cr | Accumulated amortization | $2,000 |
ABC Co.’s expenses in its Income Statement will increase by $2,000. At the same time, its Balance Sheet will report an intangible asset of $8,000 ($10,000 – $2,000).
Conclusion
Amortization is a technique used in accounting to spread the cost of an intangible asset or a loan over a period. In the case of intangible assets, it is similar to depreciation for tangible assets.
For loans, it helps companies reduce the loan amount with each payment. The accounting treatment for amortization is straightforward, as stated above.
