What is Accumulated Amortization?
Definition: Accumulated amortization is the total amount of expense recorded in a balance sheet used in the capitalization intangible assets. Simply put, it is the amount of costs used to maintain an intangible asset over duration in use. Accumulated amortization underscores regular utilization of an intangible asset, calculated on a straight-line basis.
A good number of physical assets, used in the production process, depreciate right from the day of purchase. The depreciation varied over the years and represented in the balance sheet as an expense. In contrast, intangible assets do not depreciate. Instead, there is always an amount of money used to capitalize on the assets, giving rise to what is often referred to as accumulated amortization.
Understanding Accumulated Amortization
Whenever a company or a business acquires an intangible asset, it must always account for its depletion in the balance sheet. The typical entry in a balance sheet debits the amortization expense as well as credits the accumulated amortization account. Some of the assets subject to accumulated amortization include Patents, non-competition agreements as well as licensing agreements and customer lists.
Accumulated amortization is calculated by dividing the value of the underlying intangible asset with years of its useful life. The division allows companies to report the same amount as amortization cost throughout the intangible asset life. Amortization, in this case, is done throughout the life of the asset.
Accumulated amortization is a contra asset account that is generally listed after the unamortized intangible asset line with the new amount of intangible asset calculated direct under that. Whenever an intangible asset is sold or eliminated, its preceding accumulated amortization amount is consequently removed from the financial statement.
Accumulated Amortization Example
Envision an auto parts manufacturing company granted nine-year protection for a patent worth $9 million for the production of a given engine part. While the patent is initially reflected in the balance sheet with a $9 million value, the company will have to debit $1,000,000 as amortization expense every year.
The accumulated amortization expense at the end of the nine years should amount to $9 million, which is the initial value of the intangible asset. Conversely, the accumulated amortization is the total amortization cost charged in the income statement over the nine years.
Accumulated amortization differs from depreciation on the fact that the same amount is expensed each period, over the useful life of the asset. Considering our example above, it is clear that $1,000,000 was expensed each year over the nine years. In contrast, physical assets incur different levels of deprecation, which translates to varying levels of costs in the balance sheet.
How Accumulated Amortization Affects A Balance Sheet
Businesses use accumulated amortization to spread the cost incurred in maintaining an intangible asset over its useful life. Similarly, amortization acts as a reliable tool for reducing a company’s assets as well as stockholders’ equity in the balance sheet.
Accumulated amortization also reduces an asset value in the balance sheet, consequently reducing the total value of assets in the asset section. The reduction is carried out throughout the intangible asset useful life.
Likewise, accumulated amortization affects income in the income statement consequently reducing the retained earnings of shareholders.
Summary
Accumulated amortization is used to lower the book value of an intangible asset in a balance sheet. However, if an intangible asset is likely to continue providing economic value without depreciation, then it should never be amortized. In this case, the value of the intangible asset should always be reviewed’ periodically, adjusted accordingly with impairment in the books of account.
Goodwill is a perfect example of an intangible asset that can never be amortized. Should it change, and then its value can be adjusted accordingly based on specific changing conditions rather than on a given schedule.