Intangible assets are a company’s resources that have no physical presence, such as patents, copyrights and licenses. Amortization is the process of reducing an intangible asset’s value on the balance sheet over its useful life. A company amortizes only intangible assets with a finite life. If an intangible asset has an indefinite life, you amortize it only if circumstances cause its life to become finite. Otherwise, you must test the asset for impairment, or a decline in value, annually.
About Intangible Assets
A company records the cost of an intangible asset on its balance sheet only when it purchases it from another party. Internally generated intangible assets, such as brand recognition, remain off the balance sheet. An intangible asset has an indefinite life if there are no laws, contracts or economic factors that limit its life. For example, if a company signs a license agreement with no expiration date to use another company’s logo, the license has an indefinite life.
Testing For Impairment
An intangible asset becomes impaired if its fair value falls below its book value, or the value on your balance sheet. Fair value is the value for which you could sell the asset on the open market. When impairment occurs, you report an impairment loss on the income statement and reduce the asset’s book value by the amount of the impairment loss. The impairment loss equals the asset’s book value minus its fair value.
Assume that, during an annual test, you determine that an intangible asset has a $40,000 fair value and a $50,000 book value, which means it is impaired. You would report a $10,000 impairment loss on the income statement, which is equal to $50,000 minus $40,000, and reduce its book value to $40,000 on the balance sheet. The impairment on the balance sheet is permanent. You cannot later increase the asset’s book value if its fair value increases.
Testing for a Finite Life
Circumstances may reduce an intangible asset’s indefinite life to a finite life, which a company evaluates each accounting period. For example, a new law may cause a trademark license to become obsolete. If this occurs, you first test the asset for impairment and reduce its book value on the balance sheet, if necessary. You would then amortize the asset over its remaining useful life. Amortization involves reducing the book value by an amortization expense annually and reporting the same amortization expense on the income statement annually.
Amortization expense equals an intangible asset’s book value minus its salvage value, divided by its remaining useful life. Salvage value is the estimated value at the end of its useful life. For example, assume you determine that an intangible asset with an indefinite life now has a four-year finite life. If the asset has a $40,000 book value and no salvage value, its amortization expense would be $10,000, or $40,000 divided by 4. You would reduce its book value by $10,000 annually and report a $10,000 amortization expense annually.
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