AmortizationAmortization

Unit Unit

99

Amortization is the process of allocating to expense the cost of a capital asset over its useful (service) life in a rational and systematic manner.

Cost allocation is designed to provide for the proper matching of expenses with revenues in accordance with the matching principle.

During an asset’s life, its usefulness may decline because of wear and tear or obsolescence.

Land is the only capital asset that is not amortized.

AMORTIZATIONAMORTIZATIONAMORTIZATIONAMORTIZATION

FACTORS IN CALCULATING FACTORS IN CALCULATING AMORTIZATIONAMORTIZATION

Illustration 10-6

AMORTIZATION METHODSAMORTIZATION METHODSAMORTIZATION METHODSAMORTIZATION METHODS

Three methods of recognizing amortization are: 1. Straight-line, 2. Units of activity, and

3. Declining-balance. Each method is acceptable under generally accepted accounting principles. Management selects the method that is appropriate for their company. Once a method is chosen, it should be applied consistently.

STRAIGHT-LINE METHODSTRAIGHT-LINE METHOD

Amortization Expense Truck 2,400

Accumulated Amortization – Truck 2,400

To record amortization on truck in year 1

STRAIGHT-LINE METHODSTRAIGHT-LINE METHOD

Amortization is constant for each year of the asset's useful life

STRAIGHT-LINE METHODSTRAIGHT-LINE METHODEXAMPLEEXAMPLE

DECLINING-BALANCE METHODDECLINING-BALANCE METHODDECLINING-BALANCE METHODDECLINING-BALANCE METHOD

The calculation of periodic amortization is based on a declining net book value (cost less accumulated amortization) of the asset.

The amortization rate remains constant from year to year, but the net book value to which the rate is applied declines each year.

Net Book Value (at beginning of year)

Straight-line Rate (x declining balance

rate multiplier, if any)

Amortization Expense

Rate = (100/ life of asset) * 2

DECLINING-BALANCE METHODDECLINING-BALANCE METHOD

Accelerated methods result in more amortization in early years and less in later years

DECLINING-BALANCE METHODDECLINING-BALANCE METHODEXAMPLEEXAMPLE

UNITS-OF-ACTIVITY METHODUNITS-OF-ACTIVITY METHODUNITS-OF-ACTIVITY METHODUNITS-OF-ACTIVITY METHODTo use the units-of-activity method, 1) the total units of activity for the entire useful life are estimated, 2) the amount is divided into amortizable cost to calculate the amortization cost per unit, and 3) the amortization cost per unit is then applied to the units of activity during the year to calculate the annual amortization.

Amortized Cost

Total Units of Activity

AmortizableCost per Unit

Units ofActivity during

the YearAmortization

ExpenseAmortizable

Cost per Unit

UNITS-OF-ACTIVITY METHODUNITS-OF-ACTIVITY METHOD

Useful life is expressed in terms of total units of production or activity expected from the asset

UNITS-OF-ACTIVITY METHODUNITS-OF-ACTIVITY METHODEXAMPLEEXAMPLE

COMPARISON OF METHODSCOMPARISON OF METHODS

If annual amortization is inadequate or excessive, a change in the periodic amount should be made. When a change is made,

1. there is no correction of previously recorded amortization expense and

2. amortization expense for current and future years is revised.

REVISING PERIODIC AMORTIZATIONREVISING PERIODIC AMORTIZATIONREVISING PERIODIC AMORTIZATIONREVISING PERIODIC AMORTIZATION

Revised amortization expense =Net book value at time of revision – revised salvage

valueRemaining useful life

AMORTIZATIONAMORTIZATIONAMORTIZATIONAMORTIZATION The units-of-activity method is generally

used to calculate amortization on natural resources, because periodic amortization generally is a function of the units extracted during the year.

NATURAL RESOURCESNATURAL RESOURCESNATURAL RESOURCESNATURAL RESOURCES

ILLUSTRATION ILLUSTRATION 10-2310-23 FORMULA TO CALCULATE FORMULA TO CALCULATE AMORTIZATION EXPENSEAMORTIZATION EXPENSE

ILLUSTRATION ILLUSTRATION 10-2310-23 FORMULA TO CALCULATE FORMULA TO CALCULATE AMORTIZATION EXPENSEAMORTIZATION EXPENSE

Amortizable Cost = (Cost – Residual Value + Restoration Costs)

TotalEstimated

Units

Amortization Cost per

Unit

Amortization Cost per

Unit

Number ofUnits

Extractedand Sold

AmortizationExpense

ILLUSTRATION ILLUSTRATION 10-2410-24STATEMENT PRESENTATION OF STATEMENT PRESENTATION OF

AMORTIZATIONAMORTIZATION

Accumulated Amortization, a contra asset account, is deducted from the cost of the natural resource in the balance sheet as follows:

AssetsCapital assets

Coal mine 5,000,000$ Less: Accumulated amortization 384,000 Net book value 4,616,000

Lane Coal CompanyBalance Sheet (partial)

December 31, 2003

In general, accounting for intangible assets parallels the accounting for capital assets. Intangible assets are:

1. recorded at cost;

2. written off over useful life in a rational and systematic manner;

3. at disposal, net book value is eliminated and gain or loss, if any, is recorded.

ACCOUNTING FOR ACCOUNTING FOR INTANGIBLE ASSETSINTANGIBLE ASSETSACCOUNTING FOR ACCOUNTING FOR

INTANGIBLE ASSETSINTANGIBLE ASSETS

Amortizable intangible assetsHave defined livesAllocation of the cost to expense over the shorter of

Useful (economic) lifeLegal life

Straight-line method of amortization used

AMORTIZATION OF AMORTIZATION OF INTANGIBLE ASSETSINTANGIBLE ASSETSAMORTIZATION OF AMORTIZATION OF

INTANGIBLE ASSETSINTANGIBLE ASSETS

UNAMORTIZABLE INTANGIBLE UNAMORTIZABLE INTANGIBLE ASSETSASSETS

Indefinite useful livesDo not amortizeTest for impairment