How to Amortise Your Business Assets
Amortisation is the process of spreading the cost or value of an intangible asset over a period of time. Intangible assets are non-physical assets that have a useful life, such as patents, trademarks, goodwill, software, etc. Amortisation helps businesses to match the expenses of acquiring an asset with the benefits it generates over time.
Amortisation is similar to depreciation, which is used for tangible assets like machinery, equipment, vehicles, etc. However, amortisation is based on the estimated useful life of the asset, while depreciation is based on the physical wear and tear of the asset.
To calculate amortisation, you need to know the following information:
- The cost or value of the intangible asset
- The estimated useful life of the asset
- The residual value of the asset at the end of its useful life (if any)
The amortisation expense for each period is calculated by dividing the cost or value of the asset minus the residual value by the number of periods in the useful life. For example, if a company buys a patent for $100,000 that has a useful life of 10 years and no residual value, the amortisation expense for each year is $10,000 ($100,000 / 10).
Amortisation affects both the income statement and the balance sheet of a business. On the income statement, amortisation reduces the net income and earnings per share of the business. On the balance sheet, amortisation reduces the carrying value of the intangible asset under non-current assets.
Amortisation also has tax implications for businesses. In most countries, amortisation is a deductible expense that lowers the taxable income and tax liability of a business. However, different countries may have different rules and rates for amortising different types of intangible assets. Therefore, it is important to consult with a tax professional before amortising your business assets.
Benefits and Limitations of Amortisation
Amortisation has several benefits and limitations for businesses. Some of the benefits are:
- It helps businesses to measure the profitability and performance of their intangible assets over time.
- It helps businesses to comply with accounting standards and principles that require the recognition and measurement of intangible assets.
- It helps businesses to reduce their tax burden by deducting the amortisation expense from their taxable income.
Some of the limitations are:
- It can be difficult to estimate the useful life and residual value of some intangible assets, such as goodwill, brand name, customer loyalty, etc.
- It can be subjective and inconsistent, as different businesses may use different methods and assumptions to amortise their intangible assets.
- It can understate or overstate the true value of some intangible assets, as they may have a higher or lower market value than their book value.