UK Accounting Glossary
Process similar to depreciation, usually applied to intangible fixed assets.
Spreading the cost of an intangible asset, such as a lease, over the years in which it is used. It is usual to divide the cost of the lease by the number of years that the lease is held for, and then use that figure as the annual charge.
This is similar to depreciation except that depreciation deals with tangible or fixed assets such as motor vehicles or plant and equipment.
The building up over a period of a fund to replace a productive asset at the end of it’s useful life, or to repay a loan.
In the case of a loan, the amount required for amortisation depends on the interest rate that can be earned on the accumulated fund.
In the case of replacement of physical assets, the amount needed depends not only on the interest rate, but also on the expected lifetime of the asset and on the rate of inflation, which affects the expected cost of replacement.
The key difference between amortisation and depreciation is that amortisation is used for intangible assets, while depreciation is used for tangible assets. An asset’s salvage value must be subtracted from its cost to determine the amount in which it can be depreciated.
Amortising an intangible asset
You own a patent on a machine, and that patent lasts 20 years. You spent $20,000 to design and create the machine (initial cost of the patent). You should record $1,000 each year as an amortisation expense for the patent ($20,000 / 20 years).
Amortising a loan
You have a $5,000 loan outstanding. If you pay $1,000 of the principal each year, $1,000 of the loan amortises each year. You should record $1,000 each year in your books as an amortisation expense.
Amortisation of an intangible asset is the equivalent to depreciating a tangible asset like equipment. Intangibles are assets like patents and licenses that are of significant value to a company and have an estimated useful life. The cost is amortised over the useful life to record expenses in the period they are used.