Definition:
Amortization is the process of spreading the cost of an intangible asset over its useful life. It’s similar to depreciation for tangible assets.
Key points about amortization:
- Intangible assets: Amortization applies to intangible assets, such as patents, copyrights, trademarks, and goodwill.
- Systematic allocation: The cost of an intangible asset is allocated systematically over its useful life.
- Straight-line method: The most common method for amortization is the straight-line method, which allocates the cost evenly over the asset’s useful life.
- Impairment: If the value of an intangible asset declines, it may be necessary to write it down, which reduces its carrying value.
Why is amortization important?
- Matching principle: Amortization helps to match the expense of using an intangible asset with the revenue it generates.
- Financial statements: Amortization is reflected on the income statement as an expense and on the balance sheet as a reduction in the value of the intangible asset.
- Tax implications: Amortization can affect a company’s tax liability.
In essence, amortization is the process of allocating the cost of an intangible asset over its useful life, providing a systematic way to recognize the expense associated with using that asset.
