Business owners have to face a reality that most of their assets—tangible or intangible—lose their value over time. These losses are measurable and have an impact on a business’s accounting practices. We will be tackling amortisation in this context.
Amortisation is the process of quantifying the intangible assets’ gradual losses. It means spreading out the asset’s initial cost over the duration of its lifespan or its usable life. The cost of labour and acquiring these assets can also be amortised as a capitalised cost.
When talking about loans, Amortisation refers to dividing loan payments into multiple instalments of both the principal and interest costs until the cost is fully paid. Business owners record the payment costs as expenses in their income statements instead of recording the entire cost at once.
Amortisation vs Depreciation
Amortisation and depreciation are similar. However, the two concepts differ in application.
As discussed in the first section, amortisation is used for intangible assets. A business’s intangible assets include copyrights, trademarks, goodwill, patents, brand names, licenses, software, and research and development costs.
On the other hand, Depreciation is applicable to tangible assets that have salvage value or resale value at the end of their usable life. A business’s tangible assets include machinery, equipment, and buildings that endure wear and tear over the years.
Accounting for a Business’s Amortisation
It is important to account for a business’s amortisation on a balance sheet because inaccurately recording it may constitute fraud. Because an asset’s value is not the same a few years since it was purchased, it is very important that business owners include amortisation in their income statements and accounting sheets.
Here are three questions business owners must answer to help them account for amortisation.
What is the asset’s initial value?
It is only reasonable to assess the asset’s initial value first because it will be impossible to record the amortisation without knowing its initial value correctly.
For this, owners can record the invoice reflecting the business’s cost to acquire the asset. However, since amortisation involves intangible assets, legal assistance is needed in some cases to assess the asset’s value because contractual requirements bind it.
How long is the asset’s usable life?
The next question a business owner has to answer is the duration of the intangible asset’s lifespan or usable life.
Let us use this example: A business owner purchased a design patent from another business that registered it in 2010. A design patent’s usable life is only 15 years. Therefore, its lifespan and usefulness is only 15 years.
How much is the asset’s residual value?
Lastly, a business owner also has to determine the asset’s residual value or the value that the business can sell it for after its use.
Let us use the same example. If the business owner plans to sell the design patent in five years, they have to determine its residual value for the remaining 10 years of its lifespan or usefulness.
How to Calculate Amortisation for Intangible Assets
After answering the three questions in the previous section, you may now calculate for the amortisation using this simple formula:
Amortisation Expense = Asset’s Initial Value / Asset’s Lifespan or Usable Life
Let us use the same example in the previous section. The business has a design patent that it spent many years and £800,000 in costs to develop. The design patent’s useful life is estimated at 15 years, so the business can claim £53,334 in amortisation expenses every year.
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