Amortization is the write-off of an asset over its expected period of use, which shifts the asset from the balance sheet to the income statement. It essentially reflects the consumption of an intangible asset over its useful life.
Amortization is most commonly used for the gradual write-down of the cost of those intangible assets that have a specific useful life. Examples of intangible assets are patents, copyrights, taxi licenses, and trademarks.
The amortization concept also applies to such items as the discount on notes receivable and deferred charges. The term is also used in lending, where an amortization schedule itemizes the beginning balance of a loan, less the interest and principal due for payment in each period, and the ending loan balance. The amortization schedule shows that a larger proportion of loan payments go toward paying off interest expense early in the term of the loan, with this proportion declining over time as more and more of the loan's principal balance is paid off.
Accounting for Amortization
The journal entry to record amortization for an intangible asset is:
If an intangible asset has an unlimited life, then it is still subject to a periodic impairment test, which may result in a reduction in its book value.
For example, ABC International has spent $100,000 to acquire a broadcast license that will expire and be put up for auction in five years. This is an intangible asset, and should be amortized over the five years prior to its expiration date. The entry in each year would be:
The difference between depreciation and amortization is that amortization is associated with charging intangible assets to expense over time, and depreciation is associated with charging tangible assets to expense over time. Similarly, depletion is associated with charging the cost of natural resources to expense over their usage period.