When it comes to intangible assets, the costs and expenses related to them can be extremely abstract. The acquisition cost is easy to contemplate. Bu it also comes to the seemingly arbitrary amortization expense that you must recognize each month. Then, not many business owners fully understand its implications. Generally, amortization expense is the one that you recognize in order to write down your intangible asset to fair value.
Just as you would depreciate a fixed asset, like a machine or building, you need to amortize your intangible assets. These expenses can add up, however. The effect of this expense is shown on your company’s balance sheet (reducing your assets) and income statement (increasing your expenses). As a simple example, you may have an internet domain that you purchased for $10,000 that has a 5 year life. There is an additional $2,000 each year hitting your income statement. That is why knowing how to reduce your amortization expense can help your business’s bottom line.
What Is Amortization Expense?
As explained above, amortization expense is a mechanism to allow your company to recognize the expenses associated with the acquisition and upkeep of your intangible assets. These items include things such as trade names, domain names, non-compete agreements, patents, and customer lists.
All of these items provide value to the company, but they are not physical, tangible items. You acquire a finite-lived intangible asset. hen, you need to amortize the expenses associated with purchasing or acquiring the asset over its useful life.
Who Uses Amortization Expense?
If your company has any intangible assets, amortization expense is unavoidable. Unless, of course, you have indefinite-lived intangible assets such as goodwill, which must be evaluated for impairment regularly. However, the purpose of amortization expense is to help business better match expenses with the revenues associated to those expenses. So there are chances that all companies use the amortization expenses.
You would not want to expense all of that cost in one year, you would want to do it over the entire years that it is good for. This also helps smooth expenses and keeps your company from showing high expenses in one year and then no expenses in the other years of the asset’s life.
How Much Is Usually Spent on Amortization Expense?
There is not one number that is usually spent on amortization expense. Also, spending is not really what you are doing if you have this expense. By nature, amortization expense is just the process recognizing what you already paid for over a certain period of time. The total amount of amortization expense that you recognize depends on a number of factors. The amount you pay for the intangible asset will set the baseline for the amount of amortization that you must expense over the life of the asset. The life of the asset will also drive the amount of expense that you will have to recognize each year. The type of asset will also drive the amount of expense that you have to recognize. For example, definite-lived assets vs. indefinite-lived assets.
The type of business that you are running also makes a huge difference in the amount of amortization expense that you will be recognizing. A manufacturer will have a few intangible assets, such as non-compete agreements and patents. According to the EDGAR database in the SEC Web site, general motors – the maker of automobiles, only had about $328 million in amortization expense on $166 billion in sales in 2016. Information technology firms or conglomerates are created from several different firms and have much higher levels of research and intangible assets. So, they will have higher expenses. For example, the conglomerate General Electric has several different businesses, products, and research. The company had about $1.7 billion in amortization expense on 123 billion in sales in 2016.
3 Ways in Which You Can Reduce Amortization Expense
There are really only three ways in which you can reduce the amortization expense that you recognize each year. You can spend less on your intangibles. You also have the option to increase your intangible lives. Otherwise, you can make a case that you have indefinite-lived intangibles.
1. Spend Less on Intangible Assets
You can decide on hiring better attorneys to help you negotiate lower prices. Another strategy is to streamline your acquisition process and reduce costs. You may even seek alternatives to patents and trademarks are some ways that you can decrease your intangible asset cost.
However, whatever you spend to acquire the asset affects it’s value. Your income statement is also impacted. So paying less for individual fees brings down your expense.
2. Change Your Assets’ Lives
This is another easy way to reduce the amount of amortization expense that you have to recognize. You can increase your asset’s life from 5 years to 10 years. Like this, you are effectively halving the amount of expense that you will have to recognize each year. Remember, the amount of amortization expense you are recognizing is just the acquisition cost divided by the number of years.
You must be able to make a case for why you chose the longer life, also. For example, you may have a patent that is good for 20 years. It will be difficult to explain to your auditors and the IRS why you think 30 years is the right life for the asset.
3. Make a Case That You Have Indefinite-Lived Intangibles
This means that there is no real life, or there is no way to estimate a life, that the asset will be good for. Let’s take a franchise that has no expiration date and there is no indication of when it will end. This could be a franchise in perpetuity. This asset would not be amortized, but would have to be checked for impairment each year. For example, check to make sure the carrying value on the balance sheet is lower than the asset’s fair value.
Cutting to an End
Amortization expense is something that you will not be able to avoid if you have intangible assets. It is nearly impossible to operate a competitive business without things like trademarks, patents, and non-compete agreements. You can follow the steps listed above. This way you can reduce the amount of expense that you have to recognize each month. Consequently, you will improve your income statements while keeping those assets on your balance sheet.
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