Amortization of Intangibles

What it is

Amortization of intangibles is the systematic expensing of an intangible asset’s cost over its useful or tax life. Intangible assets—such as patents, trademarks, goodwill, and other intellectual property—are written off through amortization, while physical assets are written off through depreciation.

Key takeaways

• Amortization spreads the cost of an intangible asset across periods to match expense with the revenue the asset helps generate.
• For U.S. tax purposes, most Section 197 intangibles are amortized over 15 years.
• Accounting and tax amortization amounts can differ. GAAP requires amortization to reflect the pattern of economic benefits.
• Amortization is recorded as an expense on the income statement and the related carrying amount (less accumulated amortization) appears among noncurrent assets on the balance sheet.
• IRS reporting: intangible amortization is reported using Form 4562.

How it works

For accounting, amortization ties the cost of an intangible to the periods that benefit from it. For tax purposes, rules may prescribe specific lives and methods. In the U.S., Section 197 specifies a 15-year amortization period for many purchased intangibles (patents, goodwill, trademarks, trade names, etc.). Certain items—such as commercially available, nonexclusively licensed, unmodified software—may follow different tax rules (e.g., Section 167).

Special considerations

• Goodwill: When a buyer pays more than the fair market value of a subsidiary’s net assets, the excess is recorded as goodwill and amortized or tested for impairment according to applicable standards.
• Internally generated IP: Intangible value created through R&D (for example, a newly granted patent) has economic value that must be recorded and amortized in accordance with accounting rules.
• Salvage value: Unlike depreciation of tangible assets, amortization generally does not incorporate a salvage value.

Amortization vs. Depreciation

• Amortization applies to nonphysical (intangible) assets; depreciation applies to physical (tangible) assets.
• Depreciation methods often account for salvage value; amortization typically does not.
• Tax systems often prescribe different methods: for U.S. depreciation of tangible assets, the IRS uses MACRS; for intangible assets, the IRS allows straight-line and, for certain asset types (motion pictures, sound recordings, copyrights, books, patents), an income forecast method.

Common methods

Accounting (financial reporting) methods used for amortization include:
* Straight-line
Declining balance
Annuity
Bullet
Balloon
* Negative amortization

For tax purposes, typical options are:
* Straight-line (commonly used for Section 197 intangibles)
* Income-forecast method (allowed for certain literary, musical, and patent-related assets)

Example

• Depreciation (tangible): A construction company buys a $32,000 truck with an expected salvage value of $4,000 and an 8-year life. Straight-line depreciation = ($32,000 − $4,000) ÷ 8 = $3,500 per year.
• Amortization (intangible): A company pays $300,000 for a patent with a 30-year exclusive life. Straight-line amortization = $300,000 ÷ 30 = $10,000 per year.

Where amortization appears on financial statements

• Income statement: amortization expense is shown under operating expenses.
• Balance sheet: the intangible asset is listed as a noncurrent asset with accumulated amortization reducing its carrying amount.

How to compute (straight-line)

Basic straight-line amortization:
* Amortization expense per period = (Cost of intangible − Residual value) ÷ Useful life
Note: Residual value for intangibles is often zero; many tax rules prescribe fixed lives regardless of actual useful life.

Bottom line

Amortization allocates the cost of intangible assets over time to reflect the economic benefits they provide. It differs from depreciation in that it applies to nonphysical assets and typically does not consider salvage value. Tax rules (such as Section 197 in the U.S.) often set prescribed amortization periods, while accounting standards require amortization that matches expense to revenue.