Amortization of intangibles is also known as amortization. When you amortize intangible assets, you allocate the asset's cost over its useful life for tax or accounting purposes. Such as patents, goodwill, intellectual property, and trademarks are intangible assets that amortize into an expense account called amortization.
How is this calculated? It's pretty simple. The most common way, the straight-line method, involves expensing the asset over time. Amortization can calculate; by taking the difference between the asset's cost and its anticipated salvage or book value and then dividing that amount by the total number of years, it will use. It would give you the annual amortization expense.
You then deduct this amount from your taxable income each year. The goal is to match the expense of the asset with the revenue it generates so that you don't pay taxes on phantom income.
TYPES OF AMORTIZATIONS
A company can select six amortization methods for accounting purposes, including the straight line, balloon, annuity, declining balance, bullet, and negative amortization. In contrast, the accounting depreciation methods are limited to four options: declining balance, straight line, and production units.
For tax purposes, the IRS allows two options for the amortization of intangibles. These are the income forecast method and straight line. You can use the income forecast method instead of the straight-line method in case the asset is:
- Motion Picture Films
- Copyrights
- Videotapes
- Books
- Sound Recordings
The IRS only allows the MACRS (Modified Accelerated Cost Recovery System) to depreciate physical assets.
What Are the Benefits of Amortizing Intangible Assets?
When you amortize intangible assets, you can deduct their value over time. To some extent, it is beneficial for a few reasons.
- It helps you manage your taxes.
- Amortizing intangible assets can spread the deduction over several years, reducing your taxable income in any given year.
- It also asses you keep track of your expenses. When you know how much you're spending each year on intangible assets, you can better budget for them and make sure you're getting the most value for your money.
- Amortization is a great way to manage and track your intangible assets. You can save money and time in the long run by taking advantage of it.
- Amortization assists in determining the actual value of an asset for a business.
What Are the Drawbacks of Amortizing Intangible Assets?
When you amortize intangible assets, you're allocating the cost of those assets over their useful life. We need this to match the expenses of the investments with the revenues they generate. It's necessary to understand that there are some drawbacks to this approach.
- The useful life of an intangible asset is not easy to calculate. If the useful life is incorrect, the amortizing cost would inaccurate.
- Because intangible assets are not physical, calculating their actual cost is also tricky.
- Amortizing intangible assets can harm your company's financial statements.
For instance, if you have a lot of intangible assets on your books, it can make your business look less profitable. So, weigh the pros and cons before making decisions about amortizing your company's intangible assets.
How Does Amortization Expense Impact the Cash Flow?
The expense of amortization is a non-cash expense. As a result, when creating an indirect cash flow statement, it, like all non-cash expenses, will be added to net income. The same applies to physical asset depreciation and other non-cash expenditures such as payables increases and accumulated interest expenses. These figures were all subtracted from the net sales figure to arrive at the net income, although the company didn't pay cash for these expenses. As a result, the net income figure is significantly less than the money received. Add these expenses to net income to get an accurate cash flow figure.
When Are Intangible Assets not Amortizable?
Most of the physical capital assets depreciate over time. The land is one of the few physical assets that wouldn't depreciate. However, intangible assets are far more common to have the support that never amortizes.
That's because intangible assets have longer useful lives than physical assets. If an intangible asset continues to provide economic value indefinitely without deterioration, it will not amortize. Instead, its value should be reviewed regularly and adjusted with an impairment.
How to Determine the life of Amortize Intangible Assets?
An intangible asset's useful life is more difficult to predict than a tangible asset's. The capitalized costs of "section 197 intangibles" acquired after August 10, 1993, generally be amortized over 15 years. You must amortize these expenses if you own section 197 intangibles in connection with your business, trade, or activity that generates income.
Where To Claim Amortization for Taxes?
When a business files its income tax return, it includes an amortization calculation for all allowable assets those amortize. For the estimate, you will report annual amortization deductions to the IRS Form 4562. The Amortization instructions to file the business taxes can be found in Publication 535. The form includes depreciation and depreciation calculation for a property (listed) and amortization.
Where Can You Find Intangible Asset Amortization on a Company's Financial Statements?
The amortization appears in the expenses category on the company's loss and profit statement. This figure also shows the corporate's balance sheets under non-current assets.
Conclusion
Now that you understand how to evaluate the amortization of intangible assets, you can use this information to your advantage. Amortization can be a great way to reduce your taxes and help you manage your cash flow.
Keep in mind, however, that amortization is not a cure-all. You still need to carefully consider your intangible assets and how they will affect your business. But using amortization wisely can be a powerful tool in your business arsenal.
