Amortization Defined
Amortization occurs when the value of an asset (usually an intangible asset) is reduced over a specific time period, which is usually over the asset's estimated useful life. A good way to think of this is to consider amortization to be the cost as the asset is consumed or used up while generating sales or profits for a company. Intangible assets can include a patent, trademark or trade name, or a copyright. Major inputs into the amortization process include useful life, residual value and the allocation method, the last of which can be on a straight-line basis that is mostly straightforward.
A more specialized case of the term amortization takes place when a bond that is purchased at a premium is amortized down to its par value as the bond reaches maturity. When a bond is purchased at a discount, the term is called accretion. The concept is again referring to adjusting value over time on a company's balance sheet, with the amortization amount reflected in the income statement. In this context, the asset is amortized or capitalized over time. Otherwise, an item would simply be expensed and wouldn't exist as an asset on a company's balance sheet. A rule of thumb on this is to amortize an asset over time if the benefits from it will be realized over a time period of several years (or longer). With a short expected duration (such as days or months), it is probably best and most efficient to expense the cost through the income statement. Also, amortization refers to capitalizing the value of an intangible asset over time. Depreciation is meant to refer more to capitalizing the value of a tangible asset over time; for example, a piece of equipment or office furniture that a company might purchase.
Intangible Asset Example
Other examples of intangible assets include customer lists and relationships, licensing agreements, service contracts, computer software and trade secrets (such as the recipe for Coca-Cola). Goodwill is another major intangible asset that warrants discussion as it applies to amortization. It used to be amortized over time but now must be reviewed annually for any potential adjustments. The best example of how this can impact a company's financials in a big way is the purchase of Time Warner in 2000 by America Online (AOL) during the dot-com bubble. AOL paid $162 billion for Time Warner, but AOL's value plummeted in subsequent years and required a goodwill impairment charge of between $40 billion and $60 billion (the amount was heavily debated among the company and accountants). In previous years this amount would have been amortized over time, but it must now be evaluated annually and written down if, as in the case of AOL, the value is no longer there.
GAAP versus IFRS
Firms must account for amortization as stipulated in major accounting standards. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) both have similar definitions on what qualifies as an intangible asset, but there are differences in how their values must be adjusted over time. For instance, development costs to create new products are expensed under GAAP (in most cases) but capitalized (amortized) under IFRS. GAAP does not also allow for revaluing the value of an intangible, but IFRS does. This means that GAAP changes in value can be accounted for through changing amortization schedules, or potentially writing down the value of an intangible, which would be considered permanent. Finally, GAAP stipulates that advertising expenditures be expenses as incurred, but IFRS does allow recognizing a prepayment of these expenses as an asset, which would be capitalized or amortized as they are used at a later date.
Financial Statement Examples
In its August 2013 10-K filing with the SEC, technology giant Intel (Nasdaq:INTC) provided the following exhibit related to operating expenses:
| Dollars (In Millions) | 2012 | 2011 | 2010 |
| Research and development | $10,148 | $8,350 | $6,576 |
| Marketing, general and administrative | $8,057 | $7,670 | $6,309 |
| R&D and MG&A as percentage of net revenue | 34% | 30% | 30% |
| Amortization of acquisition-related intangibles | $308 | $260 | $18 |
"Licensed technology and patents are generally amortized on a straight-line basis over the periods of benefit. We amortize all acquisition-related intangible assets that are subject to amortization over their estimated useful life based on economic benefit. Acquisition-related in-process research and development assets represent the fair value of incomplete research and development projects that had not reached technological feasibility as of the date of acquisition; initially, these are classified as "other intangible assets" that are not subject to amortization. Assets related to projects that have been completed are transferred from "other intangible assets" to "acquisition-related developed technology"; these are subject to amortization, while assets related to projects that have been abandoned are impaired and expensed to research and development. In the quarter following the period in which identified intangible assets become fully amortized, we remove the fully amortized balances from the gross asset and accumulated amortization amounts."
As you can see, the amortization concept is subject to classifications and estimates that need to be studied closely by a firm's accountants, and by auditors that must sign off on the financial statements.
The Bottom Line
The change to GDP mentioned above boosted economic growth several basis points over the last 50 years and made the economy nearly $560 billion larger than previously estimated. Now that it is considered a long-lived asset, accountants will have to measure whether to adjust or amortize the amount over time. The same goes for a firm's intangible assets on its balance sheet.
Subscribe via Email 
Subscribe RSS Comments
Lenny Ignelzi/AP WASHINGTON -- U.S. home prices rose at a faster year-over-year pace in October than in September, snapping a seven-month slowdown. Real estate data provider CoreLogic (CLGX) said Tuesday that prices increased 6.1 percent in October compared with 12 months earlier. That was up from September's year-over-year increase of 5.6 percent. Still, home values are rising more slowly than they were earlier this year, when 12-month gains were averaging nearly double their current pace. The price momentum began to tail off in the middle of the year as home values in more cities and states neared the record highs last seen shortly before the Great Recession began in late 2007. Higher prices have reduced affordability, especially because the incomes of many would-be buyers have yet to match their pre-recession levels. Lending standards also remain comparably tight. Previous price increases led investors to pull back from the home market, and first-time buyers have yet to fill the void created by their departure. Price growth will likely remain mild as a result, CoreLogic said. The firm projects that home values will rise 5.1 percent over the next 12 months. Roughly half the country's homes will match or surpass their pre-recession prices by mid-2015, it predicts. Every state reported a price gain in October. CoreLogic said prices reached new highs in Colorado, Louisiana, Nebraska, New York, North Dakota, South Dakota, Tennessee, Texas and Wyoming. In 27 states, home values are within 10 percent of their previous peaks. There are still pockets of the country -- including parts of Texas, Seattle and Denver -- where prices are rising faster than in the rest of the country because of their relatively strong job markets, incomes and home prices, said Sam Khater, deputy chief economist at CoreLogic. Other real estate companies have forecast a sharper slowdown in price gains next year. Zillow (Z), the online home marketplace, released estimated Tuesday that home values will rise a mere 2.5 percent nationwide in 2015. That slowdown should ultimately help bring more buyers into the market and increase sales, said Stan Humphries, Zillow's chief economist. Humphries said he thinks more homes will be listed for sale as prices edge closer to their previous peaks, giving buyers more options. At the same time, rental prices are expected to rise 3.5 percent. That should give people an additional incentive to buy. "As renters' costs keep going up, I expect the allure of fixed mortgage payments and a more stable housing market will entice many more otherwise content renters into the housing market," Humphries said.
Paul Sakuma