The following is an excerpt from Accounting Made Simple: Accounting Explained in 100 Pages or Less.
Intangible assets are real, identifiable assets that are not physical objects. Common intangible assets include patents, copyrights, and trademarks.
Amortization is the process—very analogous to depreciation—in which an intangible asset’s cost is spread out over the asset’s life. Generally, intangible assets are amortized using the straight-line method over the shorter of:
- The asset’s expected useful life, or
- The asset’s legal life.
Example: Kurt runs a business making components for wireless routers. In 2008, he spends $60,000 obtaining a patent for a new method of production that he has recently developed. The patent will expire in 2022.
Even though the patent’s legal life is 14 years, its useful life is likely to be much shorter, as it’s a near certainty that this method will become obsolete in well under 14 years, given the rapid rate of innovation in the technology industry. As such, Kurt will amortize the patent over what he projects to be its useful life: four years.
Each year, the following entry will be made:
- Amortization is the process in which an intangible asset’s cost is spread out over the asset’s life.
- The time period used for amortizing an intangible asset is generally the lesser of the asset’s legal life or expected useful life.