Amortisation of intangible assets is a method for paying off an intangible asset (such as goodwill) in which the asset’s cost is written off over the useful life of the asset. Intangible assets, as they do not exist in a physical form, amortisation assists companies in describing their decline in value through use, time or obsolescence. It guarantees accuracy of the financial reporting and the adoption of accounting standards such as IFRS and AS. The amortisation rules will differ according to the intangible asset, its useful life and whether it is finite or indefinite. In the real world, you would amortise a license for software or a patent over 10 years.
What is Amortisation and Why Does It Matter?
Companies use amortisation to partition the cost of intangible assets. It makes the financial reports less lenient. This way, we effectively depreciate an asset each year, similar to how we depreciation physical goods.
Amortisation Meaning in Simple Words
Amortisation is the allocation of the cost of an intangible asset over its useful life. It ensures the expense appears gradually in the profit and loss account. This enables an accurate picture of business profits.
Here’s a simple example:
For example, if a company purchases software for ₹1,00,000 and the software has a useful life of 5 years, then every year ₹20,000 will be considered expense. It is called amortisation of intangible assets.
Difference Between Amortisation and Depreciation
Amortisation and depreciation are both ways to spread the cost of assets over time. The goals may be similar, but they are applied to different asset types. By understanding their differences, it becomes easier to keep accurate financial records.
| Factor | Amortisation | Depreciation |
| Asset Type | Intangible Assets | Tangible Assets |
| Example | Patent, Trademark, Copyright | Machine, Vehicle, Building |
| Expense Term | Amortisation | Depreciation |
| Accounting Purpose | Spreads cost over useful life | Spreads cost over useful life |
| Examples | Buildings, machinery, vehicles, furniture | Patents, copyrights, trademarks, goodwill, software licenses |
Why Businesses Uses Amortisation?
Amortisation is used by businesses to match up the cost of intangible assets to the generated revenue. This provides a more accurate picture of annual profits. Amortisation is also subject to accounting rules, and maintains consistency. It assists in curtailing overstatement of asset values over the period.
- Assists in an expense matching with income
- Provides real earnings in every single year
- Depicts falling property value over the years
- Finance reports need this.
This is a very important topic in accounting studies and examinations
Amortisation of Intangible Assets Meaning
Amortisation of intangible assets is defined as the gradual reduction over time of an amount write off an intangible asset that is recognised as an expense. Such assets include patents, trademarks and software. This assists in depicting the real value of assets in firm books. Now let us dive top to bottom into amortisation of intangible assets meaning. Intangible assets are the things you cannot touch but are valuable assets for your business. These may include:
- Patents
- Trademarks
- Software
- Customer lists
- Brand names
- Franchise rights
Useful Life of Intangible Assets
As every intangible asset has a useful life. It may be fixed or uncertain. You need to amortise it if the asset has a fixed useful life.
Example:
- Trademarks last for 10 years. That’s why the cost will be incurred over 10 years.
- If we cannot guess useful life, then we do not amortise it but test it regularly for impairment.
Methods of Amortisation
Depending on how the asset is used, companies use different methods to calculate amortisation. The method must correspond to the way in which the asset generates value over time. Intangible assets can be amortised using various methods. The most common one is:
- Straight Line Method (SLM): Equal Amount each financial year
Other methods include:
- Reducing Balance Method
- Production Unit Method
For most intangible assets the straight-line method is best. We will describe both methods to amortize intangible assets.
Benefits of Amortisation
- Reduces profit manipulation
- Follows matching principle
- Ensures faithful representation in financial statements
- Under Indian Accounting Standards accepted
Amortisation of Intangible Assets as per Companies Act 2013
Amortisation of Intangible assets under Companies Act 2013 is covered by specific rules laid down under it to offer fair and uniform accounting. These rules fall under Schedule II of the Act. They assist companies in properly reporting values for assets, as well as expenses. For Indian corporates, amortisation of intangible assets as per Companies Act 2013 has huge implications. The Qualcomm law gives us the principles we should adhere to when calculating amortization.
Important Rules under Companies Act 2013
- Companies are required to comply with Schedule II of the Act.
- Intangible assets are supposed to have the useful life of the business used.
- If the useful life is not clear, it cannot exceed 10 years.
- How amortisation is calculated must be disclosed in the notes to accounts.
- Financial statements must reflect change in amortisation policy.
This is what guarantees that all companies play by the same rules. It simplifies comparisons between companies.
Example Based on Companies Act
Assume a company purchased a patent at ₹5,00,000 having a life of 5 years. So the company has to book ₹1,00,000 as amortisation every year. It must be clearly shown in the books.
Disclosure Requirements
Section 134 of the Companies Act 2013 further requires companies to disclose:
- Method of amortisation
- Useful life considered
- Changes in method (if any)
This automates the verification process, increasing investor confidence with respect to the financial data available.
How To Calculate Amortisation of Intangible Assets?
Calculating amortisation of intangible assets is done to spread out the asset cost through the years of use. This is necessary so profit can be reported accurately. It requires only three simple steps: cost, useful life and method of amortisation. In this article, you will learn the step by step process to calculate amortisation of intangible assets.
Steps to Follow
- If it was celled, name it.
- Verify the amount paid for the asset.
- Find its useful life.
- Select the amortization method.
- Use the technique once per year and lower the number.
Simple Example
| Item | Value |
| Asset | Software |
| Cost | ₹1,00,000 |
| Useful Life | 5 years |
| Annual Amortisation | ₹20,000 |
In such case, the amount of ₹20,000 would be accounted as expense each year by the company.
Amortisation Journal Entry
This year the entry will be:
| Particulars | Debit | Credit |
| Amortisation Expense A/cTo Intangible Asset A/c | ₹20,000 | ₹20,000 |
This writing-off will lower the asset value and represent the expense in the books.
Amortisation and Financial Statements
Amortisation impacts numerous areas of the company’s books. Then, it reflects under profit & loss account and balance sheet. The impact of amortisation on a company’s financial statements is immediate and felt every year. It diminishes profits as an expense and decreases the asset value on the balance sheet. This allows for a true financial picture to be given to the stakeholders.
In Profit and Loss Statement
- Presented as “Expense Aamortisation”
- Reduces profit for the year
In Balance Sheet
- Diminishes value of intangible assets
- Shows the net book value
Example:
Applicable rate of GST: 18% (9% CGST + 9% SGST) Original value of software: ₹1,00,000 Input GST: ₹18,000 Payable: ₹1,18,000
Subtraction: after 2 years: ₹1,00,000 – ₹40,000 = ₹60,000
This helps in showing the concrete value of the company’s assets.
Common Mistakes in Amortisation of Intangible Assets
Small errors in the application of amortisation of intangible assets are prevalent among many companies and students. Let us examine some of these mistakes. Both businesses and students tend to make mistakes while applying amortisation. These fallacies can let statement inaccuracies. Getting the mistakes right saves you unnecessary costly reporting headaches.
Common Errors
- Correctly checking the useful life
- Using an incorrect method of amortisation
- Not updating books yearly
- Amortization policy not disclosed in notes
Mistakes in calculation or otherwise can yield incorrect financial results. Students also need to stay away from these in exams.
How to Avoid These Mistakes
- Please remember to verify the useful age stated in the contract
- The straight-line method is used unless advised otherwise
- Keep records updated
- Adherence to Companies Act 2013 regulations
Relevance to ACCA Syllabus
Under IAS 38 (Intangible Assets), ACCA students should be aware of how intangible assets are measured, recognised, amortised and disclosed. It is crucial in Financial Reporting (FR), Strategic Business Reporting (SBR,) and Audit modules. Amortisation is a practice outside of exams and compliant by Real Statements: IFRS.
Amortisation of Intangible Assets ACCA Questions
Q1: What is the IFRS standard for amortisation of intangible assets?
A. IAS 16
B. IAS 38
C. IAS 10
D. IFRS 15
Answer: B. IAS 38
Q2: How should an intangible asset with limited useful life be amortised according to IAS 38?
A. Over the legal life only
B. Only in the case income is generated
C. Over its useful life
D. It should not be amortised
Answer: C. Over its useful life
Q3: What is the treatment for intangible assets under IAS 38, when the useful life of the asset cannot be reliably estimated?
A. Assume 20 years
B. No amortisation is allowed
C. Assume a 10-year life
D. Management’s judgment, unfettered
Answer: C. Take the 10-year life.
Q4: Which of the following is NOT an example of intangible asset?
A. Patent
B. Brand name
C. Inventory
D. Copyright
Answer C. Inventory
Q5: When some entity rewrites the useful life of some intangible asset, this rewriting is accounted as:
A. A prior period error
B. A change in accounting policy
C. Change in accounting estimate
D. A correction of an error
Answer: C. A change in accounting estimate
Relevance to US CPA Syllabus
Within the FAR section of the CPA exam, amortisation of intangible assets, per ASC 350 and ASC 805 (in the context of business combinations, asset recognition and impairment), is tested. Amortisation in accounting for intangibles under US GAAP
Amortisation of Intangible Assets US CPA Questions
Q1: Under US GAAP, the general rule for amortising such assets is:
A. Required straight-line method
B. Impairment testing alone
C. Amortise over 40 years
D. Expense immediately
Answer: B Required Straight-line method
Q2: Under US GAAP, which of the following intangible assets should NOT be amortised?
A. Franchise rights
B. Goodwill
C. Patents
D. Software
Answer: B. Goodwill
Q3: Journal Entry for annual amortisation of patent is:
A. Dr. Patent; Cr. Cash
B. Dr. Amortisation Expense; Cr. Accumulated Amortisation
C. Dr. Patent; Cr. Revenue
D. Amortisation Expense; Cr. Patent
Answer: D. Dr. Amortisation Expense; Cr. Patent
Q4: If not amortised, what do companies have to test for impairment annually, under US GAAP?
A. Trademarks
B. Goodwill
C. Software
D. Licenses
Answer: B. Goodwill
Q5: In which financial statement is amortisation reflected?
A. Cash Flow Statement
B. Changes in Equity Statement
C. Income Statement
D. Notes to Accounts
Answer: C. Income Statement
Relevance to US CMA Syllabus
Part 1: Financial Planning, Performance and Analytics teaches CMA students about amortisation as an important concept of asset management. It has to do with internal decision-making, allocation of costs and measurement of profitability related to intangible capital.
Amortisation of Intangible Assets US CMA Questions
Q1: Amortisation of intangible assets in companies leads to:
A. To avoid tax
B. To match cost with revenue
C. To increase equity
D. To boost asset values
Answer: B. To be consistent with revenue
Q2: How to treat a software license purchased for 4 Years?
A. Depreciate it
B. Expense it fully in year 1
C. Amortise over 4 years
D. Ignore it in books
Answer: C. Amortise 4 years
Q3: All of the above asset is eligible for amortisation.
A. Building
B. Machinery
C. Finite life intangible assets
D. Land
Answer: C. Finite Life – brand name
Q4: What is not an amortisable cost?
A. Purchase price
B. Legal fee
C. Training costs
D. Registration fee
Ans: C. Training costs. Training costs
Q5: For example, a company changes the useful life of its software from 3 to 5 years. This is:
A. A change in policy
B. An error correction
C. A change in estimate
D. Not allowed
Ans: C. A change in estimate (Correct)
Relevance to CFA Syllabus
Amortisation is crucial in CFA Level I and II syllabi for financial statement analysis and equity valuation. For companies that capitalise vs expense on intangible assets, analysts are forced to make modifications to earnings and asset values as they compare firms.
Amortisation of Intangible Assets CFA Questions
Q1: What is the one the amortisation decreases?
A. Revenue
B. Net income
C. Assets only
D. Liabilities
Answer: B. Net income
Q2: An analyst who is adjusting earnings must:
A. Add amortisation to net income
B. Deduct from goodwill depreciation
C. Ignore amortisation
D. No, treat amortisation as capital expense
Answer: A. Add amortisation to net income
Q3: Which financial number is directly impacted by amortisation?
A. Cash from investing
B. Gross profit
C. EBITDA
D. Sales revenue
Answer: C. EBITDA
Q4: Goodwill is recognized as:
A. Amortised over 10 years
B. Evaluated for impairment on an annual basis
C. Not recognised
D. Expensed immediately
ANSWER: B. Impairment test annually
Q5: When a company capitalises the software and amortises over 5 years, this will:
A. Decrease assets quickly
B. Generate more cash flow from operations
C. Lower amortisation expense
D. In year 1, lower profit compared to full expensing
Answer: B. Increase cash flow from operations
