Accountants use both amortisation and depreciation to spread the cost of an asset over its useful life. In this article, we explain – what is amortisation in accounting? 

What is the difference between amortisation vs depreciation? And what does all this mean for your business’ assets?

Key takeaways: What is amortisation?

Accountants use amortisation to systematically write down the cost of intangible assets over their estimated useful lives.

  • Companies must amortise intangible assets and goodwill under FRS 102, which requires a finite useful life for these assets (IFRS Accounting Standards require annual impairment testing of goodwill).
  • You determine the useful life of an intangible asset based on the period it is expected to provide economic benefits to your business.
  • If you cannot reliably estimate the useful life, apply a maximum period of ten years, HMRC confirms in its notes on accounting practice: CIRD30540 – Intangible assets.
  • You start amortising an intangible asset when it is available for use and ready for its intended operation. Companies recognise the amortisation expense in the profit and loss account as an operating cost.
  • Most UK businesses use the straight-line method to amortise intangible assets, spreading the expense evenly over the asset’s useful life.
  • On the balance sheet, you deduct accumulated amortisation from the carrying value of the intangible asset.

With amortisation, you match the cost of intangible assets with the revenue they help generate, following the accruals concept.

What are intangible assets?

Businesses own intangible assets that have no physical substance but provide future economic benefits.

  • You can find examples of intangible assets such as patents, trademarks, copyrights, licences, and goodwill.
  • Under UK accounting standards like FRS 102, you must identify intangible assets by their separability or legal rights.
  • You can either acquire intangible assets from other parties or develop them within your business, although stricter rules apply to internally generated assets. Development costs can be capitalised if certain criteria are met, but research costs must be expensed.
  • When you acquire an intangible asset, you record it on the balance sheet at its cost, including both the purchase price and any directly attributable expenses.
  • You usually amortise intangible assets over their finite useful life to systematically allocate their cost.
  • When you acquire another company and pay more than the fair value of its net assets, you recognise the excess as goodwill, a unique intangible asset.
  • Each year, you must review intangible assets for impairment to ensure you do not overstate their value on the balance sheet.

Unlike financial assets such as investments or receivables, you cannot convert most intangible assets directly into cash, but they remain vital for your company’s long-term success. Some can be sold or licensed, such as patents or software.

Difference between amortisation and depreciation

When you amortise an intangible asset, you recognise the reduction in its value due to legal or economic limits on its useful life.

You apply depreciation to tangible assets such as buildings, machinery, vehicles, and equipment, while you use amortisation for intangible assets like patents, trademarks, and goodwill.

  • When you depreciate an asset, you account for its physical wear and tear or obsolescence over time.
  • For tangible assets, you may use either the straight-line method or accelerated methods, such as reducing balance, depending on the asset’s nature.

You report both amortisation and depreciation as non-cash expenses in the profit and loss account, which reduces your taxable income.

On the balance sheet, you deduct accumulated depreciation from the value of tangible assets and accumulated amortisation from intangible assets.

When you depreciate a tangible asset, you often consider its potential resale value at the end of its useful life, but you typically assume no residual value when you amortise an intangible asset.

You distinguish between the two by the type of asset: you depreciate tangible assets and amortise intangible assets, but both methods help you match asset costs with the income they generate.

How to calculate amortisation

To calculate amortisation, you first determine the initial cost of the intangible asset and estimate its useful life.

  • You usually use the straight-line method, dividing the asset’s cost evenly over its useful life to find the annual amortisation expense.
  • For example, if you acquire a trademark for £30,000 with a six-year useful life, you amortise £5,000 each year (£30,000 ÷ 6 years).
  • If the asset has no residual value at the end of its useful life, you allocate the full cost across the chosen period.
  • In some cases, you may use alternative methods such as the reducing balance or annuity method, but the straight-line method is most common in the UK.
  • You must ensure the amortisation method reflects how you expect to consume the asset’s future economic benefits.
  • Each year, you record the amortisation expense in the profit and loss account and reduce the carrying value of the asset on the balance sheet.
  • If you cannot reliably estimate the useful life, UK accounting standards typically require you to use a maximum period of ten years.

You should regularly review the asset for impairment and adjust the amortisation schedule if its value declines unexpectedly

Final thoughts: Amortisation in accounting

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