Don't Forget Amortization

Amortization expense is similar to depreciation, except it works only for intangible assets. This expense measures decline in the value of those assets over time. How do intangible assets decline in value? Well, they don't wear out or rust, but some of them, such as patents, have specific end dates. Others, such as licensing agreements, come with clear useful lives.

The running total of amortization expense is held in a contra account, which generally is called accumulated amortization. The reasoning here is the same as it is for depreciation: this allows you to see the original value of the asset separately from how much of it has been “used up.” For amortization, though, you actually have another choice, which you don't have for depreciation: you can record amortization directly to the intangible asset account.

Also unlike depreciation, amortization can only be calculated on a straight-line basis. This means that each period, the exact same amount is booked to expense until it's all used up. If your company bought a patent for $15,000 that had 15 years left until expiration, you would amortize $1,000 per year for 15 years.

You can't amortize any intangible asset over more than 40 years, even if it has a much longer legal or useful life. If the asset's useful or legal life is shorter than 40 years, though, you have to use that shorter time span when you figure out the expense.

Although it may seem as if amortization won't apply to your company, it probably will. The most common amortization expense for small business is start-up costs. While you're doing all the things you have to do to get your business started, there's no actual business for which you can deduct those expenses.

Instead, you have to lump the expenses into an asset and amortize them over five years. Expenses you would typically put into this account include legal fees, business licenses, incorporation fees (or the equivalent for LLCs or partnerships) — any expense you incur to create the company.

  1. Home
  2. Accounting
  3. Standard Operating Expenses
  4. Don't Forget Amortization
Visit other About.com sites: