Amortization is often regarded as being the same as depreciation, but although the two accounting practices can be difficult to distinguish, there are differences between them. Amortization is also used in connection with loans, although that is not the primary focus here.
What It Measures
Amortization is a method of recovering (deducting or writing off) the capital costs of intangible assets over a fixed period of time. Its calculation is virtually identical to the straight-line method of depreciation. Amortization also refers to the establishment of a schedule for repaying the principal and interest on a loan in equal amounts over a period of time. Because computers have made this a simple calculation, business references to amortization tend to focus more on the terms first definition.
Why It Is Important
Amortization enables a company to identify its true costs, and thus its net income, more precisely. In the course of their business, most enterprises acquire intangible assets such as a patent for an invention, or a well-known brand or trademark. Since these assets can contribute to the revenue growth of the business, they can beand are allowed to bededucted against those future revenues over a period of years, provided the procedure conforms to accepted accounting practices. For tax purposes, the distinction is not always made between amortization and depreciation, yet amortization remains a viable financial accounting concept in its own right.
Amortization
Covenants not to compete: an agreement by the seller of a business not to engage in a competing business in a certain area for a specific period of time. The cost of the not-to-compete covenant should be amortized over the period covered by the covenant unless its estimated economic life is expected to be shorter. Easement costs that grant a right of way may be amortized if there is a limited and specified life. Organization costs incurred when forming a corporation or a partnership, including legal fees, accounting services, incorporation fees, and other related services. Organization costs are usually amortized over 60 months. Patents, both those developed internally and those purchased. If developed internally, a patents amortizable basis includes legal fees incurred during the application process. Normally, a patent is amortized over its legal life, or over its remaining life if purchased. However, it should be amortized over its legal life or its economic life, whichever is the shorter. Trademarks, brands, and trade names, which should be written off over a period not to exceed 40 years. However, since the value of these assets depends on the changing tastes of consumers, they are frequently amortized over a shorter period. Other types of property that may be amortized include certain intangible drilling costs, circulation costs, mine development costs, pollution control facilities, and reforestation expenditures. They can even include intangibles such as the value of a market share or a markets composition: an example is the portion of an acquired business that is attributable to the existence of a given customer base.
More Info
Websites:
Financial Accounting Standards Board: www.fasb.org US Copyright Office: www.copyright.gov US Patent and Trademark Office: www.uspto.gov
Amortization
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