What is amortisation?

What does amortisation mean?

In accounting, amortisation is the process of spreading out the cost of an intangible asset over its useful life. This is typically done for assets such as patents, copyrights, trademarks, and goodwill. Amortisation is similar to depreciation, which is the same process for tangible assets.

Unlike physical assets that depreciate (wear out), intangible assets have a finite useful life over which their value is expected to decline. Amortisation allocates the cost of these assets proportionally over their estimated useful life, reflecting a gradual decrease in their value on the company’s financial statements.

Why should businesses amortise intangible assets?

The value of intangible assets may decline for several reasons. A few common exampels are:

• Patents eventually expire, making the invention public knowledge.
• Copyrights might become less valuable as new creative works emerge.
• Consumer preferences can change, making a trademark less recognisable.
• Franchise agreements have a defined term.
• Brand names can lose their luster if not carefully managed.

In bookkeeping, amortisation aligns the expense of using the intangible asset with the revenue it helped create over its useful life, leading to more transparent financial statements.

How is amortisation calculated?

To calculate amortisation, you first need to determine the cost of the intangible asset and its estimated useful life. Divide the cost of the asset by the number of periods in its useful life to find the annual amortisation expense.

Amortisation = Cost of Intangible Asset / Useful Life

For example, if you have an intangible asset that costs $10,000 and has a useful life of 5 years, the annual amortisation expense would be $10,000 divided by 5, which equals $2,000 per year. By properly calculating and recording amortisation expenses, businesses can ensure their financial statements accurately reflect the true value of their intangible assets over time.