Amortization of intangible assets

From CEOpedia | Management online

Amortization of intangible assets is the monetary equivalent of the consumption of the value of property rights (fixed assets) purchased by an enterprise, which are intended to be used for its needs, and their useful life will exceed 12 months, caused by its physical wear and tear - resulting from operation and economic (moral) - resulting from technical progress, related to the possibility of obtaining on the market e.g. modern machines, equipment more efficient, cheaper to use, allowing to obtain better quality products. This impairment is transferred to the value of products manufactured using depreciated fixed assets.

Amortisation is a type of cost that does not constitute a monetary expense. These costs include write-downs for the systematic and planned distribution of the initial value of both fixed assets and intangible assets (excluding goodwill) (S. Owolabi, A. A Theophilus, 2017, pp. 22-23).

Amortization is an objective expression of the expenditures that are necessary to produce goods and services. Amortization commences no earlier than after the month following the month in which the asset is entered into the register (according to the tax law) is taken into use (according to the balance sheet law), and ends when the write-offs are equal to the initial value of a specific fixed asset or when the asset is put into liquidation, sold or deficiency is found (S. Owolabi, A. A Theophilus, 2017, pp. 23-24).

Amortization does not apply to intangible assets that have been withdrawn, are intended for liquidation or sale. It is also worth noting that some intangible assets are excluded from the amortization obligation. They include primarily (M. Blair, S. Wallman, 2003 p.449-450):

  • perpetual usufruct right to land,
  • components put to free use,
  • some buildings or dwellings,
  • works of art,
  • museum exhibits.

Intangible assets

Intangible assets are property rights purchased before the enterprise, which are intended to be used for the enterprise's needs and their useful life will exceed 12 months. Intangible assets are classified as fixed assets. This means that they should be recognized in the financial statements when, and only when, the financial statements are free of material misstatement:

  • it is probable that in the future it will be possible to obtain property benefits from them,
  • it is possible to value them reliably (R. Blaug, R. Lekhi, 2009,pp.21-25).

Property rights include in particular:

  • Copyright and related rights,
  • licenses and concessions,
  • rights to inventions, patents, trademarks, utility, and ornamental designs,
  • know-how, i.e. the right to use industrial, commercial, scientific or organizational knowledge,
  • acquired goodwill,
  • costs of completed development rights,
  • property rights accepted for use under the lease, tenancy or hire purchase agreements are classified as non-current assets (R. Blaug, R. Lekhi, 2009,pp.21-25).

These rights may be classified as intangible assets if their expected useful life is longer than one year, they are intended for the company's own needs or put into use under a lease or hire agreement, and they are suitable for economic use. In addition, intangible assets include:

  • costs of completed development work i.e. costs incurred for the development of new products and technologies. They include costs incurred by a company before starting production or applying technology and costs incurred for research or other acquisition of knowledge that may contribute to the introduction of new technology or improvement of production methods (M. Cohen, 2009, pp.24-26).

These costs can, therefore, be divided into two categories:

  • Research costs - arise from activities aimed at acquiring new knowledge, seeking new and improved alternative equipment, processes or services,
  • costs of completed development work - these are capitalized costs that have a strictly defined manufacturing process and the technical feasibility of the product has been established and documented,
  • goodwill, i.e. the difference between the cost of acquisition and fair value of goodwill. In other words, goodwill is the company's assets less its liabilities (S. Henning, Lewis B. Shaw W., 2000, pp.375). Goodwill arises when the purchase price of a specific entity or its part is higher than the fair value of the net assets acquired. In addition, it arises as a result of a business combination, which involves the acquisition of a share in the net assets of the company being acquired. Goodwill is subject to linear amortization over a period of 5 years(S. Henning, Lewis B. Shaw W., 2000, pp.376).

Characteristics of intangible assets

Intangible assets do not have a physical form, therefore their identification may be difficult. International Accounting Standards (IAS 38) specify how to determine whether an intangible asset can be an intangible asset. According to these standards, a given asset can be identified when:

  • It is separable and disposable, for example, by sale, transfer, licensing or giving to third parties for use against payment;
  • arises from contractual or other legal rights, whether or not transferable.

Under international accounting standards, only acquired assets may be intangible assets, except for costs of completed development work. Intangible assets may be purchased :

  • by way of a separate transaction,
  • in a business combination transaction,
  • by way of a government grant,
  • through the exchange of intangible assets (L. Hunter, E. Webster, A. Wyatt, 2005, pp. 12-16).

Amortization features, conditions and benefits

Amortization is primarily functional (M. Blair, S. Wallman, 2003 p.:458):

  • depreciation
  • cost-intensive
  • Replacement
  • Revenue.

In accordance with tax regulations, intangible assets may be amortized if they are:

  • are owned or co-owned by the taxpayer,
  • were accepted for paid use with simultaneous inclusion into the assets of the taxpayer.

You can make amortization write-offs on the initial value of intangible assets from the first day of the month following the month in which a given value was entered into the records. Write-offs may be charged once at the end of a tax year or monthly or quarterly. Amortization of intangible assets lasts until amortization write-offs are equal to their initial value. Making amortization write-downs results in a reduction of the tax base, thanks to which you, as an entrepreneur, will pay lower income tax. The amount of depreciation write-downs depends on the initial value of depreciable assets, the method of depreciation and how often you will make depreciation write-downs (S. Powell, 2003, pp 797-811).

Minimum period for amortization making write-offs for intangible assets

As an entrepreneur who wants to depreciate intangible assets, you are required to determine the method, depreciation rate and time of depreciation on your own. Thanks to this, you can adjust depreciation write-downs to your company's cost policy (M. Blair, S. Wallman, 2003 p. 465). However, you must remember about certain limitations introduced by tax regulations concerning minimum periods of depreciation write-offs for intangible assets (M. Blair, S. Wallman, 2003 p.:466-468):

  • 24 months - for licenses for computer programs, copyrights, film screening, and radio and television broadcasting;
  • 36 months - depreciation on incurred costs of completed development works;
  • 60 months - from other intangible assets.

Examples of Amortization of intangible assets

  • Goodwill: Goodwill is an intangible asset that arises when a company acquires another company for a price higher than the fair market value of its net assets. The difference between the purchase price and the fair market value of the net assets is recorded as goodwill.
  • Patents: A patent is an exclusive right granted by a government to an inventor for a limited period of time, usually 20 years, to make, use, and sell an invention. Patents can be amortized over their expected useful life.
  • Copyrights: A copyright is a form of legal protection provided by the government to creators of works of authorship such as literature, music, and films. Works created by an individual are protected by copyright law and can be amortized over their expected useful life.
  • Trademarks: A trademark is a form of intellectual property protection that allows a company to identify and distinguish its goods and services from those of its competitors. Trademarks can be amortized over the expected useful life of the trademark.

Limitations of Amortization of intangible assets

  • Amortization of intangible assets can be limited by the fact that they are not subject to physical wear and tear and therefore cannot be measured directly.
  • Another limitation is that there is no uniform accounting standard for amortization of intangible assets.
  • Intangible assets such as goodwill, brand value, and intellectual property rights may be difficult to accurately measure, making it difficult to calculate their amortization.
  • It may also be difficult to determine the useful life of intangible assets and the method used to amortize them.
  • Amortization of intangible assets may also be limited by the fact that the value of the asset may decline over time.

Other approaches related to Amortization of intangible assets

In addition to the traditional approach of amortization of intangible assets, other methods of accounting for intangible assets can be used, such as:

  • The cost model: Under this method, the cost of the intangible asset is recognized in the period in which it is incurred. Amortization is then calculated over the expected useful life of the asset.
  • The revaluation model: This method requires the intangible asset to be revalued every accounting period, either through the use of market value or other appropriate measurement.
  • The relief from royalty method: This method is used in the case of the acquisition of a license or patent, in which the cost of the acquisition is spread over a period of time and amortized over the useful life of the asset.

In summary, there are a variety of methods for accounting for intangible assets, such as the cost model, the revaluation model, and the relief from royalty method. Each method has its own advantages and disadvantages, and the most appropriate method should be selected based on the circumstances.


Amortization of intangible assets — recommended articles
Depreciation vs. amortization — Depreciation of fixed assets — Trade exchange — Effective gross income — Business personal property — Sum of years digits method — Matching principle — Value added tax — Nonmonetary assets — Theory of entrepreneurship

References

Author: Barbara Lech

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