Amortization is the process of slowly converting the cost of an asset into a tax-deductible expense. You do this by booking expense journal entries for part of the asset's cost over the amortization period, which is always longer than one year. Each journal entry requires a debit to an amortization expense account and a credit to the accumulated amortization account.
Amortizing Intangible Assets
Amortization applies to valuable intangible assets, which are ideas sometimes called intellectual property, and include licenses, patents and copyrights. For most items, the period of amortization is fixed by tax rules or by the expected lifetime of the asset. You figure the annual amortization amount by dividing the asset's cost by the number of years in the amortization lifetime . Amortization uses a straight-line calculation, meaning the amounts are the same each year. Accumulated amortization is a contra-asset account, which means it reduces the net value of the associated asset.
How To Account for Amortization
Suppose a company receives a 20-year patent that it values at $1 million. At the start, the company books a long-term asset for $1 million. Each year for 20 years, the company debits the patent amortization expense account and credits the patent accumulated amortization account for $50,000, which is ($1 million / 20). After the first year, the net value of the patent becomes $1 million minus $50,000, or $950,000. The process repeats each year until the patent expires.