Intangible assets
Assets refer to something that creates earnings or brings value to a person or company. Tangible assets refer to things that are physically real or perceptible to touch. Equipment, vehicles, office space, and stock are all common tangible assets of a company.
An intangible asset refers to things that cannot be physically touched but are real nonetheless.
Therefore, such business assets could be:
- Government licenses
- Patents
- Rights to a film
- Copyrights
- Trade marks
- Goodwill
Loans
Loan amortisation is paying off the debt of something over a specified period. A business that uses this option is building equity in the loaned asset while paying off the item at the same time. At the end of the amortised period, the borrower will own the asset outright.
When looking at loans for your company, some things to consider are interest rates and the principal payment as well as the debt covenants of business loans, and the financial leveraging of said debts.
Depreciation vs. amortisation
Depreciation and the amortisation of assets are similar accounting concepts. However, depreciation refers to spreading the cost of a fixed asset out over time. In contrast, amortisation is the spreading of costs associated with the life of an intangible asset. The recording of these two types of payments within your financial documents will differ.
To accurately record the periodic payment of an intangible asset, two entries are made in the company’s books. First, a debit to the amortisation expense is entered, then a corresponding credit to the intangible asset account is entered. Depreciation, on the other hand, would have a credit placed in the contra asset accumulated depreciation.
What is an example of amortisation?
A definition of an amortised intangible asset could be the licensing for machinery or a patent for your business. Suppose a business makes a specific car part for high-end vehicles. The creation of this car part uses schematics that are patented. Therefore, the company’s intangible asset is this schematic patent.
If the patent runs for 30 years, the company must calculate the total value of the intangible asset to the company and spread its monthly payment over this asset’s life. This accounting function allows the company to use and capitalise on the patent while paying off its life value over time.
What is Goodwill Amortisation?
As goodwill is an intangible asset, goodwill amortisation effectively reduces the value of
the goodwill asset in gradual amounts over a ten-year period on a straight line basis.
Scheduling period payments
If a company is going to amortise something, it will have an attached amortisation schedule. This schedule is a table detailing the periodic payments of said loan amount or asset. These regular installments are generated using an amortisation calculator. The allocation of costs over a specified period must be paid in full by the time of the maturity date or deadline.
How do you calculate amortisation?
There are easy-to-use amortisation calculators that can help you figure out the best loan principal repayments schedule, taking into account the interest rates and loan type and terms.
One of the trickiest parts of using this accounting technique for a business’s assets is the estimation of the intangible’s service life. Business operators must weigh out the economic value to the company, including the book value, residual value, and the useful life of the intangible asset.
Many intangibles have a specific legal life attached to them. However, the service life could be considerably shorter than the legal life of an intangible asset. Generally, the amortisation of these assets must be at least 15 years.
Straight-line method
The straight-line method is the equal dispersion of monetary installments over each accounting period. Generally, this method is the go-to scheduling of payments for businesses. It allows for steady expenses throughout the allocated time.
The expense is calculated as the amortisation cost divided by the intangible asset’s estimated useful life, using equally allocated payments. The formula is as follows:
Amortisation = (Book Value – Residual Value) / Useful Life
