Amortization

Amortization Expense

• Definition:

  • Amortization is the allocation of the cost of intangible assets over the number of years these assets are expected to aid in revenue generation for a company.
  • Conceptually identical to depreciation, often grouped under the term "depreciation and amortization" (D&A) in financial statements.

• Key Distinctions:

  • Amortization deals exclusively with intangible assets, while depreciation applies to fixed assets.
  • Both amortization expense and depreciation expense appear on cash flow statements under a single line item labeled D&A.

Amortization of Intangible Assets

• Process:

  • When a company acquires an intangible asset, the cost is not recognized immediately but is instead spread over the asset's expected useful life through amortization expense.

• Types of Intangible Assets:

  • Common forms include:
  • Customer lists
  • Franchise rights or memberships
  • Licenses
  • Patents and technologies
  • Trademarks
  • Goodwill:
  • Special type of intangible asset, typically discussed separately.
  • Goodwill, like some trademarks, is considered to have an indefinite useful life.

Unique Characteristics of Certain Intangible Assets

• Indefinite Useful Life:
  • Trademarks and goodwill are viewed like land and are not amortized due to their indefinite nature.
  • Typically, amortization expense will not appear associated with goodwill or trademarks.

Example Scenario: Google and Patent Acquisition

• Example:

  • Google acquires patents for $30,000,000, with an expected useful life of 10 years.

• Amortization Calculation:

  • Annual Amortization Expense = Total Cost / Useful Life
  • $Annual Amortization Expense = \frac{30,000,000}{10} = 3,000,000$
  • Google recognizes $3,000,000$ annually on the income statement for the next 10 years.

• Financial Disclosure Insights:

  • In its 10-K disclosures, Google indicates recognized value for intangible assets around $6,000,000,000$.
  • Regarding amortization, the disclosed expenses for 2013 were $1,151,158,000$.
  • Future amortization expectations are as follows:
  • Next Year: $1,000,000,000$
  • Continuing similar amounts for the next years.
  • Post-2018 expectation is $1,600,000,000$ for fiscal 2019 and beyond.

Important Distinction in Internal Development

• Internally Developed Intangible Assets:
  • Costs related to the development of intangible assets (such as patents) are fully expensed in the year incurred.
  • Under US GAAP, companies cannot increase the value of intangible assets, following the historical cost and conservatism principles.
  • Negligible Costs Recognized:
  • Costs such as legal and filing fees for patents are recognized as incurred and not amortized.

Exercise Overview: Classification of Expenses

• Task:
  • For each listed item, determine if it should be amortized, depreciated, fully expensed, or none of the above. Also, categorize the expense type.

Item Classification:

1. Cost of building an automotive factory:

   • Classification: Depreciated
   • Expense Reporting: Cost of Goods Sold (COGS)

2. Cost of building an office for administrative staff:

   • Classification: Depreciated
   • Expense Reporting: SG&A or Other Operating Expenses

3. Cost of salaries for assembly labor:

   • Classification: Fully Expensed
   • Expense Reporting: Cost of Goods Sold

4. Cost of acquiring a customer list:

   • Classification: Amortized
   • Expense Reporting: Other Operating Expenses

5. Cost of patent filing fees (internally developed):

   • Classification: Fully Expensed
   • Expense Reporting: Other Operating Expenses

6. Cost of acquiring a trademark:

   • Classification: Not Amortized
   • Expense Reporting: Trademarks with indefinite useful lives sit on the balance sheet and do not depreciate or amortize.

Conclusion

• Understanding the distinction between the treatment of intangible assets (acquired vs. internally generated) is critical for accurate financial reporting and analysis.
• The accounting treatment aligns with the principles of conservatism and historical cost, reflecting the recognition and valuation of intangible assets on the balance sheet.
• Both amortization and depreciation represent noncash expenses that impact income statements without affecting cash flow directly.