Amortization, in accounting, refers to the technique used by companies to lower the carrying value of either an intangible asset. Amortization is similar to depreciation as companies use it to decrease their book value or spread it out over a period of time. Amortization, therefore, helps companies comply with the matching principle in accounting.
A line item will exist on the balance sheet for intangible assets. Patents allow inventors the exclusive rights to produce and sell their new inventions, as long as it is new, not obvious, and useful. Instead of using a contra‐asset account to record accumulated amortization, most companies decrease the balance of the intangible asset directly. In such cases, amortization expense of $10,000 is recorded by debiting amortization expense for $10,000 and crediting the patent for $10,000. Amortization of intangible assets is handled differently than depreciation of tangible assets.
Additionally, based on regulations, certain intangible assets are restricted and given limited life spans, while others are infinite in their economic life and not amortized. When you record patent expenses and amortization costs, you must record the number in both the patent amortization expense account ledger and the patent asset account ledger. For example, if the annual amortization expense were $5,000, you would enter a debit to the amortization expense account of $5,000, and a credit to the patent asset account for $5,000.
We can make the journal entry for patent amortization by debiting the amortization expense account and crediting the patents account. Tangible assets are expensed using depreciation, and intangible assets are expensed through amortization. Depreciation generally includes a salvage value for the physical asset—the value that the asset can be sold for at the end of its useful life. The annual wave accounting tutorial depreciation expense on a straight-line basis is the $32,000 cost basis minus the expected salvage value—in this case, $4,000—divided by eight years. The annual deprecation for the truck would be $3,500 per year, or ($32,000 – $4,000) / 8. For accounting purposes, there are six amortization methods—straight line, declining balance, annuity, bullet, balloon, and negative amortization.
Patents need to be amortized regularly over the course of their life. Report the preliminary patent price on the corporate ledger as an asset. Include an annual entry for amortization expenses that reduces the asset account until it reaches zero.
Residual value is the amount the asset will be worth after you’re done using it. To record the amortization expense, ABC Co. uses the following double entry. Lastly, the credit to the cash or bank account is the amount of repayment made by the company. It decreases the cash balances of the company on the Balance Sheet.
XYZ Ltd purchased a patent for 50,000 which is expected to expire after five years. Show the entry for amortization expense charged each year on the patent. Patriot’s online accounting software is easy-to-use and made for small business owners and their accountants. When an asset brings in money for more than one year, you want to write off the cost over a longer time period. Use amortization to match an asset’s expense to the amount of revenue it generates each year.
For example, imagine that your small enterprise acquires an organization with property with an actual worth of $100,000 and liabilities totaling $50,000. You count on the useful lifetime of the property to equal five years. The calculation for the straight-line methodology is ($100,000 – $50,000) / 5, which equals $10,000. Your organization must debit amortization expenses for $10,000 and credit score goodwill for $10,000 yearly for the next five years.