What is Amortisation?
Amortisation is the accounting method of spreading the cost of an intangible asset over a certain period of time which is greater than one year.
What is an Intangible Asset?
Intangible assets include things such as:
Intangible assets have no physical state but is still an asset to the business.
How to Calculate Amortisation
To calculate amortisation you first need to make an estimate of the useful life of the intangible asset. Useful life in accounting refers to the number of years the asset in question will remain in service to the business and contribute to income generation. The value of the intangible asset will be written off in equal amounts over the useful life.
Amortisation = Cost of Intangible Asset / Useful Life of Intangible Asset
An Example of Intangible Asset Amortisation
A business registers a trademark costing £20,000 and it is estimated that the trademark has a useful life of 10 years. Therefore the trademark will be amortised at £2,000 per year (£20,000/10 years).
The amortisation at £2,000 is not a cash entry, it is a book entry in the accounts reflecting the decrease in value of the trademark.
The Effect On Your Financial Statements
Your profit and loss account will include the amortisation amount each year over the useful life of the intangible asset. In the example above £2,000 would be charged to the profit and loss account, reducing profit, for 10 years reflecting the sentiment that a portion of the cost of the asset has been used each year to earn income over 10 years.
The reduction in profit therefore means retained profit each year is reduced, hence lowering shareholders funds on your balance sheet.