Depreciation on intangible assets, more accurately referred to as amortisation, is the process of systematically allocating the cost of an intangible asset over its useful life. Unlike tangible assets, intangibles don’t wear out physically, but they lose value over time due to legal limits, market changes, or obsolescence. Amortisation ensures that the asset’s cost is matched with the revenues it helps generate, promoting accurate and consistent financial reporting. Intangible assets are not physical, but essential for running a business. They help a business earn money, just like machines or buildings. Depreciation on intangible assets means reducing their value slowly over time. This reduction happens because these assets lose power to earn as time passes. Proper accounting ensures correct profits and balances.
What are Intangible Assets?
Intangible assets are valuable even when they cannot be touched. These include rights, software, and even business names. A company must keep records of these assets. This shows the true wealth of the company. It also helps when showing data to investors or filing tax returns.
Types and Examples of Intangible Assets
Some intangible assets last for a fixed time. Others may last forever. Trademarks can protect a brand name for 10 years or more. Patents can help earn money from inventions. Even customer loyalty is counted when goodwill is recorded. These assets increase the brand’s power in the market.
Often, companies show them in the intangible assets in the balance sheet under non-current assets. This shows they will benefit the business for a long time. Companies must keep these updated. Wrong values can lead to wrong profits and reports.
If any asset loses its value early, companies must immediately reduce it. This is called impairment. For example, a trademark may lose value if the brand closes. These changes must be reported fast.
Accounting for Intangible Assets
Companies follow strict rules when recording intangible assets. They use intangible assets accounting standards such as AS 26. This tells what to record and what not to. Only assets bought or created for business use are included. Future profit alone does not count unless linked to a clear asset.
Firms must also track the costs spent on creating the asset. These include legal charges, testing fees, or research costs. Only direct costs go in. Indirect ones, like salary or rent, do not count. This ensures a clear value is recorded.
After entering the books, the value must be reduced each year. This is called intangible asset amortisation. It matches the expense to the year in which it is earned. This rule helps compare costs with earnings.
Useful Life of Intangible Assets
Each intangible asset helps the company only for a time. This is called the useful life of intangible assets. The firm checks legal rights or market use. A license may expire. A patent may lose value if new tech arrives.
Firms must decide on a useful life at the start. They must write down the reason. This helps during audits. If life changes later, the firm must also change future expenses. This keeps all values fair. After this time, the asset value becomes zero. Then, it must be removed from books. If the value remains, it must be written off. This ensures the balance sheet does not show wrong values.
Understanding Depreciation on Intangible Assets
Depreciation on intangible assets means slowly reducing the value of non-physical assets like patents, trademarks, or copyrights over time. Businesses record this loss of value every year to show the true worth of their assets. Just like machines lose value, intangible assets also lose value because of time, use, or legal limits. Depreciation helps companies match the asset’s cost with the income it helps to earn.
How to Depreciate Intangible Assets?
When an intangible asset starts helping a business, the company reduces its value slowly. This process spreads the cost over the years. If software is helpful for five years, 1/5th of its price decreases yearly. This way, the cost matches the revenue it helped earn.
This is shown in the depreciation schedule for intangible assets. This schedule lists how much value is removed each year. It helps track the remaining value, too. This also helps in planning future purchases and updates. Accountants make sure each year’s profit reflects the correct cost. This avoids sudden significant losses in one year. It also shows the real company position. If the asset is unused or its value drops, faster reduction may happen.
If an asset stops working early, the full cost must be removed. This happens when software is no longer supported. Or when laws change, making a license useless. These losses are added to expenses.
Intangible Asset Depreciation vs Physical Asset Depreciation
Though people say depreciation for both, the methods differ. Machines are reduced due to their use. Software or patents are reduced because of time or rules. Also, physical assets may have some value left at the end. But most intangible ones do not. Still, both help reduce taxes. And both show the real cost of running the business. Proper records help when companies sell, merge, or go public. They also help banks and investors decide value and risk.
| Basis of Comparison | Intangible Asset Depreciation (Amortisation) | Physical Asset Depreciation |
| Nature of Asset | Non-physical (e.g., patents, trademarks, copyrights) | Physical/tangible (e.g., machinery, buildings) |
| Term Used | Amortization | Depreciation |
| Accounting Standard | IAS 38 (Intangible Assets) | IAS 16 (Property, Plant, and Equipment) |
| Useful Life | Finite or indefinite (indefinite assets not amortised) | Usually finite |
| Residual Value Consideration | Often assumed to be zero | Residual value is estimated and deducted |
| Method of Allocation | The straight-line method is commonly used | Straight-line, reducing balance, units of production |
| Impairment Testing | Annual test if indefinite; otherwise, as needed | Done when there is an indication of impairment |
| Example | Amortising a software license over 5 years | Depreciating machinery over 10 years |
Why Depreciation and Amortisation Matter?
Reducing asset value on paper keeps books honest. It avoids fake high profits. It also helps plan when new assets are needed. The firm can save for its replacement if an asset is near its life.
Many investors check the financial statements of intangible assets. They want to see if the company is using its assets well. If an asset costs a lot but earns little, it is a red flag. Amortisation shows how much of an asset is still in use.
Tax departments also look at these records. Correct amortisation can save money. Wrong values may lead to fines or audits. So, clear schedules and records are essential
Amortisation vs Depreciation
Many confuse amortisation vs depreciation, but knowing the difference is vital. These two reduce asset values. However, the assets they apply to and their use are different. Companies use depreciation for machines or buildings. They use amortisation for patents or trademarks. Depreciation may include wear and tear. Amortisation uses time or expiry date.
Even the journal entries differ. Depreciation affects machinery accounts. Amortisation affects accounts like software or patents. But both go under expenses. They reduce profits but show real business costs. Different laws set rules for each. Like AS 10 for fixed assets and AS 26 for intangible ones. These ensure every asset type is handled the right way.
| Feature | Amortisation | Depreciation |
| Applies To | Intangible assets (e.g., patents, trademarks, goodwill) | Tangible assets (e.g., machinery, vehicles, buildings) |
| Nature of Asset | Non-physical assets | Physical, fixed assets |
| Method | Mostly straight-line method | Straight-line or reducing balance method |
| Recorded In | Profit & Loss account | Profit & Loss account |
| Residual Value Considered? | No | Yes (commonly considered) |
| Example | Amortising a software license over 5 years | Depreciating a machine over 10 years |
Features That Separate Amortisation and Depreciation
Some assets lose value faster. Others last longer. The choice of method depends on asset type. Depreciation may use fast or slow methods. Amortisation mainly uses the straight-line method.
For example, if a truck loses more value early, firms use the double-declining method. However, software or patents do not work this way. They reduce value evenly. This makes accounting easier. Also, the amortisation journal entry does not include the salvage value. Most intangible assets do not have resale value. Once expired, they are worthless. Depreciation may consist of the leftover value at sale.
Importance of Clear Distinction
Mixing these can lead to big mistakes. It can show wrong profits. It can lead to incorrect tax filings. It may affect company valuation. Investors and tax officers may not trust the reports.
Firms must train accountants well. Software used for accounting must also handle both methods. Good software can give alerts when the value falls or the license ends. This avoids losses. Also, intangible assets, GAAP clearly states how amortisation must be done. This helps in audits and overseas dealings. Following this keeps businesses safe and reliable.
Methods Used to Calculate Amortisation of Intangible Assets
Amortisation is the systematic reduction of the book value of an intangible asset over its useful economic life. Like depreciation for tangible assets, amortisation spreads the cost of an intangible asset (like software, patents, or trademarks) across the periods in which it provides value. The most common methods are listed below:-
1. Straight-Line Method (Most Common)
The straight-line method spreads the cost of an intangible asset equally over its useful life. It’s simple, predictable, and aligns with assets offering yearly economic benefits. Ideal for software, licenses, or patents with consistent usage and impact.
- How it works: An Equal amount is amortised every year.
- Formula:
- Best for: Assets that provide consistent benefits over time.
- Example: A ₹100,000 patent with no residual value and a 5-year life = ₹20,000 amortisation annually.
2. Declining Balance Method
Declining method records higher amortization in the initial years, tapering off over time. It reflects assets that lose value or offer peak performance early in their lifespan. Though rare for intangibles, it’s useful when early benefit realization is clear.
- How it works: Amortisation is higher in the earlier years and decreases over time.
- Best for: Assets are expected to generate more benefits early in life.
- Note: This is rarely used for intangible assets; more common in tangible fixed assets.
3 Sum-of-the-Years’-Digits Method (SYD)
SYD is an accelerated amortisation method that emphasises the asset’s early-stage value. It uses a fraction based on the remaining life years to assign heavier costs up front. Best for assets with rapidly diminishing utility, like fast-evolving tech solutions.
- How it works: A faster amortisation method. Assigns more cost to early years.
- Formula: Uses a fraction based on the asset’s remaining life.
- Best for: When the intangible asset loses value or usefulness faster in the early stages.
4. Units of Production Method (or Use-Based)
This approach ties amortisation directly to the actual usage or output of the asset. Ideal for assets like licensed software with user limits or performance thresholds. It ensures cost allocation aligns with real-world consumption or utilisation.
- How it works: Amortisation is based on usage rather than time.
- Example: A software license with a user-based cap.
- Best for: Assets whose benefits are tied to usage or output.
Example Breakdown (Straight-Line)
Software License Purchase Price: ₹120,000
Useful Life: 4 years
Residual Value: ₹0
Annual Amortization: ₹120,000 ÷ 4 = ₹30,000/year
Journal Entry Each Year:
| Amortization Expense A/c Dr ₹30,000 To Accumulated Amortization ₹30,000 |
Applying the Amortisation Journal Entry
Every year, the company reduces the asset’s value in the books. This entry is simple but essential. It helps match costs with income. This keeps profit reports fair. The asset value in the balance sheet goes down. The expense in the income statement goes up. This balance keeps the records correct. Investors and auditors rely on this data for analysis. Also, good records help if the company sells or merges. Buyers can check how much value is left in each asset. If this is not clear, deals may fail.
Amortisation Journal Entry
Amortisation is recorded to systematically reduce the value of an intangible asset over its useful life. The journal entry ensures that the expense is matched with the revenues it helps generate, maintaining accurate financial reporting. The Journal entry is given below:-
| Amortization Expense ₹X,XXX To Accumulated Amortization ₹X,XXX |
Relevance to ACCA Syllabus
ACCA covers the concept of depreciation on intangible assets under IAS 38 Intangible Assets, forming part of the Financial Reporting (FR) and Strategic Business Reporting (SBR) papers. ACCA students must understand the difference between amortisation and depreciation, how to measure useful life, and how these affect financial statements. It is crucial for compliance, reporting accuracy, and valuation.
Depreciation On Intangible Assets ACCA Questions
Q1: What is the correct term for appreciating intangible assets in IFRS?
A) Depreciation
B) amortisation
C) Depletion
D) Capitalisation
Ans: B) amortisation
Q2: According to IAS 38, what should a company consider when deciding the useful life of an intangible asset?
A) The asset’s market value
B) Expected technological changes
C) Revenue earned in the current year
D) Current asset turnover
Ans: B) Expected technological changes
Q3: Which intangible assets are not amortised under IAS 38?
A) Copyrights
B) Licenses
C) Goodwill
D) Software
Ans: C) Goodwill
Q4: What happens when an intangible asset becomes impaired?
A) Its useful life increases
B) It is reclassified as a current asset
C) Its carrying value is reduced
D) No accounting adjustment is needed
Ans: C) Its carrying value is reduced
Q5: Amortisation of an intangible asset should begin:
A) At the contract signing date
B) On the purchase date
C) When the asset is available for use
D) At the end of the financial year
Ans: C) When the asset is available for use
Relevance to US CMA Syllabus
For a US CMA (Certified Management Accountant), understanding amortisation of intangible assets is part of Part 1: Financial Planning, Performance, and Analytics. It supports internal decision-making, valuation of assets, and proper cost allocation in management reporting and forecasting.
Depreciation On Intangible Assets US CMA Questions
Q1: Which is the correct accounting treatment for amortisation in management reporting?
A) Revenue recognition
B) Cost of goods sold
C) Operating expense
D) Non-operating income
Ans: C) Operating expense
Q2: What type of intangible asset can generally be amortised?
A) Internally generated goodwill
B) Trademark with indefinite life
C) License with a definite term
D) Brand name not recognised
Ans: C) License with a definite term
Q3: What is the primary goal of amortising intangible assets in managerial accounting?
A) Reduce taxes
B) Increase cash flow
C) Allocate cost over useful life
D) Recognise asset impairment
Ans: C) Allocate cost over useful life
Q4: In cost behaviour analysis, amortisation is considered:
A) Variable cost
B) Fixed cost
C) Step cost
D) Mixed cost
Ans: B) Fixed cost
Q5: What financial statement shows the cumulative amortisation of intangible assets?
A) Cash Flow Statement
B) Income Statement
C) Balance Sheet
D) Notes to Financial Statements
Ans: C) Balance Sheet
Relevance to US CPA Syllabus
Understanding amortisation is essential in FAR (Financial Accounting and Reporting) for US CPA candidates. Under ASC 350 – Intangibles – Goodwill and Other, CPA candidates must know when to capitalise, how to amortise, and how to test for impairment. It ensures GAAP compliance in external reporting.
Depreciation On Intangible Assets US CPA Questions
Q1: Under US GAAP, which intangible assets are subject to amortisation?
A) Goodwill
B) Trademarks with indefinite life
C) Patents with a legal term
D) Internally generated brands
Ans: C) Patents with a legal term
Q2: What is the default amortisation method for intangible assets under US GAAP?
A) Sum-of-the-years-digits
B) Double declining balance
C) Straight-line method
D) Units of production
Ans: C) Straight-line method
Q3: If an intangible asset has a useful life of 10 years and no residual value, what is its annual amortisation expense for a $50,000 cost?
A) $2,500
B) $5,000
C) $10,000
D) $50,000
Ans: B) $5,000
Q4: How often must intangible assets with indefinite lives be tested for impairment?
A) Monthly
B) Quarterly
C) Annually
D) Every 5 years
Ans: C) Annually
Q5: Where is the amortisation expense for intangible assets typically recorded?
A) Statement of Cash Flows – Investing
B) Income Statement – Operating Expense
C) Balance Sheet – Current Liabilities
D) Cash Flow – Financing Activities
Ans: B) Income Statement – Operating Expense
Relevance to CFA Syllabus
Amortisation is key to understanding asset valuation and income statement analysis in the CFA Level I and II Financial Reporting and Analysis sections. CFA candidates must analyse how intangible asset treatment affects profitability, risk, and valuation ratios.
Depreciation On Intangible Assets CFA Questions
Q1: How does amortisation of intangible assets affect a company’s net income?
A) It increases net income
B) It reduces net income
C) It has no effect
D) It is added back to revenue
Ans: B) It reduces net income
Q2: How does amortisation impact return on assets (ROA)?
A) It increases ROA
B) It has no impact
C) It reduces ROA
D) It multiplies ROA
Ans: C) It reduces ROA
Q3: If an intangible asset is amortised over too long a period, what financial effect does it have?
A) Overstated expenses
B) Overstated income
C) Understated income
D) Understated cash flow
Ans: B) Overstated income
Q4: Under IFRS, internally generated goodwill:
A) Can be amortised
B) Must be capitalised
C) Cannot be recognised
D) Can be depreciated
Ans: C) Cannot be recognised
Q5: Amortisation affects which section of the cash flow statement under the indirect method?
A) Operating activities
B) Investing activities
C) Financing activities
D) Equity activities
Ans: A) Operating activities
