Amortization of Intangible Assets
As we learned earlier, the intangible assets can have finite lives or indefinite lives. For assets with finite lives, the cost is amortized over the life of the asset. The procedure and methods of amortization are the same as for depreciation, i.e., straight-line method, accelerated depreciation methods, and units-of-production method. Just like tangible assets we estimate the useful life and salvage value of the intangible assets also. Their impact on financial statements is also the same.
For assets with indefinite lives, there is no amortization. Instead a test of impairment is conducted at least once a year to check if the assets are impaired. If there is impairment, then the value of the asset is reduced and the reduction is recognized as a loss in income statement. An example of an unidentifiable intangible asset with indefinite life is goodwill created as a result of business combination.
Example
A company acquired another company and as a result of the business combination, it acquired the following intangible assets:
Copyright = $200,000
Trademark = $500,000
Franchise = $200,000
Goodwill = $300,000
Total intangible assets = $1,200,000
The company expects to sell the copyright after 5 years for $50,000
The trademark will expire in 10 years.
The franchise agreement will expire in 5 years which the company can renew at a small fee.
We can use any depreciation method to calculate the depreciation. Using the straight-line method, the depreciation of each intangible asset will be calculated as follows:
Copyright = (200,000 – 50,000)/5 = $30,000
Trademark = 500,000/10 = $50,000
Franchise is an indefinite asset as it can be renewed for a small fee. So, it will not be amortized. Goodwill also is an indefinite asset and will not be amortized.
Total amortization expense = $30,000 + $50,000 = $80,000
At the end of the first year, the carrying value (book value) of intangible assets will be:
Intangible assets: $1,200,000
Less Accumulated amortization: -80,000
Net intangible assets: 1,120,000
