Lesson Objectives:- The difference between finite and indefinite intangible assets
- Recording intangible amortization using the straight-line method
- Calculating simple and complex forms of amortization
Intangible assets are normally long term in nature with a minimum of 1-year lifespan but normally at least five years. In the previous lesson, we discussed different types of intangible assets. Now, let's dig more into the differences between finite and indefinite types of intangible assets.
Finite assets have a limited lifespan and a defined useful life. This type of intangible asset can be amortized because it has an end of life while indefinite assets cannot be amortized. An example would be a franchise that has a useful life of 5 years.
Indefinite assets are not subject to a maximum amount of time that the intangible asset can be in existence. Try not to confuse this term with infinite as it differs in the sense that the term can be renewed. The difference between indefinite intangibles and finite intangibles is the fact that with an indefinite asset, there are no legal or regulatory restrictions on the lifespan.
Let's expand on the examples of a finite asset and how the amortization entries would be recorded.
We will go ahead and analyze two different examples of how finite assets are recorded.
Example 1: The company purchased the franchise on January 1st, 2010 for the amount of $30,000. The useful life of this intangible asset is 5 years.
If we were to use the straight line and look at how much the amortization is expensed each year, we would simply divide the $30,000 by the 5-year useful life. Note that since this is an intangible asset, the salvage value would be $0. This would give us a $6,000 per year amortization expense amount.
Next, if we needed to find out the carrying value of the franchise at the end of the first year, we would subtract the accumulated amortization expense of $6,000 from the cost of $30,000 to come up with $24,000. The journal entry for this amortization expense on December 31, 2010 would be a debit to the amortization expense account for $6,000 and a credit to the accumulated amortization expense account for $6,000.
$30,000 - $6,000 = $24,000 Carrying Value
One thing to note is that similar to tangible assets such as property and equipment, the accumulated amortization for intangibles will not be listed on the balance sheet. The net value for intangible assets is recorded and the accumulated amortization expense is listed in the comments section for each intangible item.
Now, let's move on to the next example which is much more complex.
Example 2: The company purchased a trademark on July 31, 2012 for $60,000 with a useful life of 30 years. They encountered a $10,000 legal expense to uphold the trademark on August 31, 2013. For the purpose of this example, we will be finding the amortization expense for the year of 2016 and the carrying value on December 31, 2016.
Since this example is a bit more complex, it helps to look at a relevant timeline of events related to the expenses of this intangible asset. We will discuss step-by-step how to calculate the values in green (amortization expenses), red (carrying values) and yellow (cost values).
First, we would note the time between July 31, 2012 and August 31, 2013 is 1 year and 1 month. We calculate the amortization expense for the year first by dividing the cost of $60,000 by the 30 year useful life to come up with a $2,000 per year expense amount.
To find out the month value, the $2,000 would be multiplied by 1/12 months which would give us a $ 167 expense amount if we rounded up to the nearest dollar. Thus, the total expense from July 31, 2012 to August 31, 2013 would be $2,167. Next, to get the carrying value for August 31, 2013, we would subtract the $2,167 from the cost of $60,000. This would give us a carrying value of $57,833.
At the August 31, 2013 milestone, the company is encountering an additional $10,000 legal expense which we would need to add to the carrying value of $ 57,833 to give us a new cost value of $67,833. Now we will just need to calculate the rest of the amortization expenses for this timeline.
To find the new amortization expense, we would first determine the amount of time we have left which is 28 years and 11 months which is equal to 347 months. The new cost value of $67,833 would be divided by 347 to come up with $195.48 per month.
The next time milestone between August 31, 2013 and Dec 31, 2015 is 2 years and 4 months, therefore we would amortize 28 months' worth of expenses which gives us $5,473. The new carrying value would be $52,360 which is found by subtracting the initial carrying value by the new amortization expense.
Either the monthly or yearly amortization can be calculated but for the purpose of this example, it is easier to explain the monthly. For the final year time period, we would simply multiply 12 months by the monthly amortization expense of $195.48 to conclude with $2,345.76. The final carrying value at the end of Dec 31, 2016 would now be $50,014.24.
Hopefully you were able to follow along with these examples and finish this lesson with a better understanding of how amortization is calculated for finite intangible assets. In the next lesson, we will be reviewing the impairment of intangible assets.