Amortization: Allocation of cost of intangible assets (patents, goodwill)

Amortization of intangible assets is an accounting process that systematically expenses the cost of an intangible asset over its useful life. It is similar to depreciation, which applies to tangible assets, but amortization specifically deals with non-physical assets.

Purpose:

The primary purpose of amortizing intangible assets is to align the expense of the asset with the revenue it generates over time, adhering to the matching principle in accrual accounting. This practice ensures more accurate financial reporting by reflecting the gradual decline in the asset's value or usefulness. Additionally, amortization is a non-cash expense that reduces a company's taxable income, thereby lowering its tax liability. It also aids in budgeting by allowing businesses to predict annual costs.

Examples of Intangible Assets Subject to Amortization:

Intangible assets are non-physical assets that hold value for a business and typically have a finite useful life. Common examples include:

• Patents and intellectual property: These grant exclusive rights to an invention or process for a set period.
• Copyrights: Legal rights granted to creators of original works, such as literary, dramatic, musical, and artistic works.
• Trademarks and brand names: Symbols, designs, or phrases legally registered or established by use as representing a company or product.
• Software licenses and development costs: The cost of acquiring or developing software that provides benefits over multiple years.
• Customer lists and relationships: Acquired through mergers and acquisitions, representing the value of an existing customer base.
• Franchise agreements: Rights granted to operate a business under a franchisor's name and system.
• Non-compete agreements: Contracts that restrict an individual or entity from engaging in competitive activities.

It's important to note that intangible assets with an indefinite useful life, such as goodwill or certain brands, are generally not amortized but are instead subject to annual impairment tests.