Study Notes on Amortization and Intangible Assets

Overview of Accounting for Intangible Assets

• Objective Seven:

  • Demonstrate accounting for the income of assets subsequent to acquisition, including amortization and recognition.

  • Focus shifts from initial acquisition to the entire lifecycle of tangible and intangible assets.

Amortization of Intangible Assets

• Definition and Context:

  • Amortization is akin to depreciation for tangible assets, specifically pertaining to the allocation of an asset’s cost over its useful life for finite life intangible assets.

  • Key difference: Amortization does not use an accumulated amortization account—expenses are directly deducted from the asset account.

  • Applicable to intangible assets with a finite life but not to those with an indefinite life (e.g., goodwill).

• Recording Amortization:

  • Amortization expense is reported on the income statement.

  • It reduces the carrying value of finite life intangible assets on the balance sheet.

  • Calculation follows the shorter of useful life or legal life of the asset.

• Estimation:

  • Despite potential estimations of residual values, these are rarely implemented in practice.

Examples of Amortization

• Case Study: JJ Incorporated

  • Context: Leased office building, initiated a 20-year lease 15 years ago.

  • Improvements: Paid $20,000 for installation of a heating and cooling system.

  • Useful Life: Estimated usage of 10 years.

  • Amortization Period: Calculate amortization based on the shorter remaining lease term of 5 years versus the asset's useful life of 10 years.

• Journal Entries for Amortization:

  • Record the initial leasehold improvement: debit Leasehold Improvement and credit Cash for $20,000.

  • Annual recording of amortization expense for the remaining life:

  • Calculation: $rac{20,000}{5} = 4,000$ per year.

  • Debit Amortization Expense and credit Leasehold Improvement for $4,000 each year for 5 years leading the Leasehold Improvement account to zero by the end of the term.

Disposal of Intangible Assets

• Firms must remove intangible assets from their books upon disposal or when they no longer expect to benefit economically from them.

• If disposed of assets have a book value remaining, it results in a loss.

• Upon selling an intangible asset, the difference between the book value and selling price determines gain or loss, similar to tangible PP&E assets.

Disclosure Notes for Intangibles

• Disclosure requirements are straightforward:

  • Similar to the approach taken with PP&E, firms must list their policies regarding intangible assets.

  • Detail amounts associated with both indefinite and finite life intangible assets.

  • Describe the amortization method employed, including whether it's based on useful life or legal life.

  • It is important to document the nature of intangible assets, such as goodwill, alongside any changes identified.

Final Notes

• The prior discussions briefly covered amortization issues and their impact on income and the balance sheet.

• A subsequent video will address non-monetary exchanges, expected to be longer than this video but shorter than the first two.

• Encourage questions for clarity on discussed topics.