The amortization of intangibles involves the consistent reduction in the recorded value of an intangible asset over time. Amortization refers to the write-off of an asset over its expected period of use (useful life). Intangible assets do not have physical substance. Examples of intangible assets are:
- Customer lists
- Government licenses
- Noncompetition agreement related to an acquisition
- Taxi licenses
Intangible assets are usually purchased from other entities, or are recorded as a result of the acquisition of another entity, and so are much less frequently recorded in the accounting records than tangible fixed assets. However, intangible assets recorded as part of acquisitions are frequently of considerable size, so the amortization method and useful life associated with them can have a profound (and negative) impact on the reported profits of the acquiring entity. It is non uncommon for an acquiring entity to experience years of losses as it gradually writes off the intangible assets associated with an acquisition.
Once amortization begins, it is rarely changed unless there is evidence that the value of the intangible asset being amortized has become impaired. If so, there is an immediate write-down in the remaining value of the intangible asset in the amount of the impairment. At that point, you must evaluate whether the useful life of the asset has also changed, and modify the amortization calculation to incorporate not only the new useful life, but also the remaining (reduced) carrying amount of the asset.
For example, ABC International acquires another company, and as a result recognizes a customer list asset in the amount of $1,000,000. ABC elects to amortize this intangible asset over the next five years at a rate of $200,000 per year. After one year, the carrying amount of the asset has been reduced to $800,000, but ABC now estimates that the asset has a market value of only $300,000 and a remaining useful life of just two years. Accordingly, ABC incurs a $500,000 impairment charge to write down the value of the asset to $300,000, and then re-sets the associated amortization to be $150,000 in each of the next two years. After that time, the customer list asset will have a carrying amount of zero in the accounting records of ABC.