How to Amortize an Expense Journal Entry

Causes of amortization can also include expiration and obsolescence.

Matching Principle is the accounting rule that requires revenues and expenses to be recorded together in the same time periods based on their causal relationship. Since impermanent assets lose their value through their usage in business operations, this value loss must be recorded as expenses in the time periods of their usefulness. Amortization is the process that represents this phenomenon for long-term, intangible assets with finite usefulness. Long-term means that the assets will exist long enough to lose value in this manner, intangible means that the assets are not physical objects, and finite usefulness means that their existence is impermanent.

Instructions

1. Estimate the intangible asset’s useful lifespan and its residual value upon disposal. Useful lifespan is the time span that the asset remains useful in the business’s operations. Residual value upon disposal is the price that the asset can be sold for once it is useless. Both parameters can be estimated by examining the parameters of similar assets. For example, if a patent lasts 20 years and has no value once it expires, it is reasonable to conclude that a similar patent also has an useful lifespan of 20 years and no residual value upon disposal.

2. Choose either a straight-line method or a declining-balance method to calculate the amortization expense in each time period. The straight-line method allocates an equal portion of the asset’s amortizable value as an amortization expense in each time period. In contrast, the declining-balance method allocates a set percentage of the asset’s remaining amortizable value in each time period.

3. Calculate the amortization expense for the asset. First, the asset’s amortizable value needs to be calculated as being equal to its purchase price minus its estimated residual value upon disposal. For example, assume that the above patent has $40,000 in value and the aforementioned 20 years in useful lifespan. Under the straight-line method, its amortization expense is $2,000 in each of the 20 years. Under the declining-balance method, its amortization expense in each of the 20 years depends on the amortization rate used. Assuming a 10 percent rate, the amortization expense is $4,000 in the first year, $3,600 in the second year, $3,240 in the third year, and so on.

4. Record the amortization expense as being a debit under amortization expense and either a deduction from the asset or its accumulation in an account called accumulated amortization. For example, the $2,000 amortization expense is recorded as a $2,000 debit under amortization and a $2,000 credit to either the asset or its accumulated amortization account.

References

• AccountingCoach: Depreciation
• AccountingCoach; What is a capital expenditure vs. a revenue expenditure?; Harold Averkamp
• AccountingCoach; What does amortization mean?; Harold Averkamp