How to Amortize Costs

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One of the main principles of accural acconting is the "matching principle." This says that the cost of an asset should match its use or the income it is bringing in. As most assets don't last forever, a business will write off a certain amount of the asset each year. The process of writing off these expenses is called depreciation for physical assets and amortization for intangible assets, like a patent, software or even a brand.

  • Review the formula for amortizing costs. The formula is: cost of the asset / useful life.

  • Determine the cost of the asset, which is the price you paid for it. For example, let's say you just bought a software program for $5,000.

  • Determine the useful life of the asset. This can tricky. Software usually has a very short useful life, whereas a patent usually has a useful life of 17 years. The useful life depends on the amount of time the asset can create value for you or your company. Let's say the software has a useful life of three years.

  • Calculate the annual amortization costs associated with the software. The calculation is: software cost ($5,000) / useful life (three years) = $1,666.67. This means that each year the amortized cost of the software is $1,666.67. This is the amount that can be written off each year.

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