Classification

When a corporation obtains an intangible asset that depreciates over time, it is important to reduce its value on its balance sheet over time. Account of amortization expense is to be debited, while accumulated amortization is to be credited.

The sum of amortization expense is known as accumulated amortization, which is documents intangible assets based on their cost, usefulness, and lifetime assigned. At the same time, the production of its units is usually taken to be the compensation that the company is likely to make to have the ownership of the primary intangible asset.

Businesses often take it to spread the cost of the useful life of maintaining an intangible asset. It is a solid method for reducing a company’s assets and stockholders’ equity on the balance sheet. The decrease is carried out only over its useful life.

Described, it is taken as the total cost incurred in maintaining an intangible asset. Accumulated amortization, which is done based on straight-line, emphasizes the continual use of an intangible asset. Intangible assets are not subject to depreciation. Instead, a certain amount of money is always set aside to capitalize on the assets, resulting in what is known as accumulated amortization.

A balance sheet is capable of reducing the book rate of an intangible asset. If, on the other hand, such an asset is anticipated to provide profitable value indefinitely without depreciation, it should never be amortized. In this instance, the intangible asset’s value should be assessed regularly and adjusted for impairment in the account books.

Recognition

When a firm or a business buys an intangible asset, it must account for its depreciation on the balance sheet. Amortization expense is debited while the accumulated amortization account is credited in a typical balance sheet entry.

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Following are some of the intangible assets that are subject to accumulated amortization:

  • Customer lists
  • Noncompetition agreements
  • Licensing agreements
  • Patents (A patent is a government-granted exclusive right to manufacture a certain product for 17 to 20 years. Other producers are not allowed to make the same goods during this time. This “right,” or patent, is a company’s intangible asset.)

However, because the patent will expire in a few years, and amortization charge must be included in the company’s income statement each year. It’s important to keep in mind that amortization is usually calculated on a straight-line basis. Accumulated amortization refers to the sum of these payments.

It is recorded as a contra asset account on the balance sheet; therefore, it is listed below the line item for unamortized intangible assets. The remaining sum of intangible assets is reported directly under it. It is rarely reported as a distinct line entry on the balance sheet. In most cases, accumulated amortization is included in the accumulated depreciation line entry, or intangible assets are presented as remaining accumulated amortization within a particular line entry.

Accumulated amortization is a good way to figure out how much intangible assets are worth and how beneficial they are.

Some important points to differentiate accumulated amortization include:

  • It is usually mixed up with depreciation. On the contrary, the primary distinction between both of the amortization can be taken in account for intangible assets but depreciation is utilized only for tangible assets. Even though both may seem to be very comparable in terms of their calculation or accumulation methods.
  • According to current accounting principles, a company must evaluate its intangible assets every year at least for current valuation and note them as accumulated amortization. It is one of the methods recommended by GAAP (Generally Accepted Accounting Principles) for adjusting the fair value of company’s intangible assets on the balance sheet as of the up-to-date market value.
  • It also has an impact on net income because it diminishes the retained earnings. As it is frequently displayed like a distinct item on the balance sheet as a usual business routine. For example, a $60 million amortized value will diminish the revalue of retained earnings at the same rate. Comprehending it as a counter asset account is another way to look at it.
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Measurement

Accumulated Amortization is a total value that is defined symbolically as:

Accumulated Amortization = ∑ Amortized Asset Value Each Year

The price of the primary intangible asset is divided by the years of its useful life to determine accumulated amortization. The division enables businesses to report the same amount as amortization expense over the life of an intangible asset. In this situation, amortization occurs over the asset’s lifetime.

Remaining is the price of an intangible asset that has not been allocated to amortization expense yet and is considered the unusual price of an intangible asset subtracted by its accumulated amortization. The linked total of accumulated amortization is likewise eliminated from the balance sheet as an intangible asset is finished.

Amortization can be calculated using three different ways. Regardless of the approaches employed, it is critical to comprehend the residual value, intangible asset’s usefulness, and the impact on actual distribution and production costs.

  • Units of Production Technique – It assigns costs based on how useful this intangible asset was in the production of tangible items.
  • Accelerated Method: It uses a weighted average strategy to deliver additional worth in the early years while less value as time goes on. It is centered around the economic theory of reducing marginal utility, which states that every year’s increases are smaller than the previous year’s.
  • Units of Production Technique – It assigns costs based on how useful this intangible asset is in the production of tangible items.

Example

Alan’s Engineering is a software development company that caters to engineering firms. For its efforts, it has various registered trademarks, copyrights, and patents. This year, a $20,000 project was finished, and a patent with a 20-year life was obtained.

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Alan will subtract amortization expense and credit accumulated amortization for $1,000 after the first year (total purchase price divided by useful life in years). Every year, Alan will make this journal entry to record the current amortization expense and the total expense throughout the asset’s life. Each year, the updated accumulated total will be noted down on the balance sheet, and the present expense will be reflected on the income statement.

When it comes to Accounting Principles, it is crucial to remember that accumulated amortization of assets is generally confined to particular long-term assets.

Starting with the patents, which allow the owner exclusive production rights for a long period. Then there is the issue of copyrights. The owner of copyrights has the right to duplicate a product for a set length of time. Additionally, some trademarks have been the “faces” of a corporation for years (for example, Burger King’s “whopper”).

Finally, licenses grant an organization or individual the authority to execute a specific act or sell a specific product. Leaseholds are payments made to a lessor to assure that an asset will be sold. Calculate the amortization rate for each of these examples, as well as the period of the agreement.