What Is Amortization Expense?
Before digging into the meaning of Amortization Expense, Let us begin with the definition of an expense.
What is an Expense?
An expenditure is a business‘s operational cost incurred to produce income. It may be described as the price one must pay to acquire something. It takes money to make money, as the adage goes.
Amortization Expense / Liability
A write-off of an intangible asset throughout its anticipated usage, or amortization expenditure, represents the asset’s consumption. The residual asset balance decreases as a result of this write-off over time.
The cost assigned to intangible assets throughout their useful life is known as amortization. The only distinction between this approach and the fixed asset depreciation process is that alternate and accelerated expenditure technique are often not permitted. Instead, the straight-line design must be used for amortization unless the corporation can show how and why another preferred method is more suited.
What Do You Mean by Amortization Expense?
Non-physical assets employed in a company’s operations are known as intangible assets. Patents, copyrights, and licenses are a few examples. Because the assets reflect a concept, contract, or legal right rather than a tangible object of property, they differ from tangible fixed assets.
It would not be appropriate to cost these assets as soon as they are purchased because they will benefit the firm for many years. Instead, intangible assets are capitalized when bought and shown as non-current assets on the balance sheet. Costs are distributed among these assets throughout their useful lives to comply with the matching principle.
Calculating Amortization Cost
Almost usually, amortization is computed on a straight-line basis. Since it is difficult to demonstrate that intangible assets are consumed more quickly in the first few years of their useful life, accelerated amortization methods aren’t very effective. Accounting for amortization costs involves debiting the account for amortization expenses and crediting the account for cumulative amortization.
Detailed Presentation of Amortization Cost
The income statement typically lists the amount of an amortization expenditure write-off under the “depreciation and amortization” line item. On the balance sheet, the intangible assets line item is coupled with and placed after the cumulative amortization account as a counter account. Some balance sheets may combine it with the line item for cumulative depreciation to show just the net balance.
Example
A corporation called Air and Space creates innovations for the aviation sector. For its inventions and improvements, it has several patents and copyrights. However, only one patent, which cost the business $10,000, was awarded this year. Since patents only last for 20 years, Air and Space would create a journal entry debiting amortization expenditure and crediting cumulative amortization to record the $500 in amortization expense for every year of the patent’s useful life.
FINAL INSIGHT
The steady decrease of an asset or debt by some recurring amount is known as amortization, an accounting term comparable to depreciation. When it comes to a purchase, this entails depreciating the thing over time, and it is anticipated to be used up. On the other hand, a liability’s amortization occurs when the item is paid for or earned. Essentially, it is a way to assign different assets and obligations to the appropriate time periods.
