What is the meaning of the financial term amortization in financial statements?
Let’s discuss the definition of amortization, review how large the annual amortization expense
is for several large and well-known companies,
and even take a look at the amortization journal entry.
Here’s an example of the use of the accounting term amortization.
In the financial statements of Apple Inc for their fiscal year 2017, we find a line “Depreciation
and amortization” of $10.2 billion.
The vast majority of that is actually for depreciation of property and equipment.
Let’s zoom in to see specifically how much amortization expense is in there, and what
it is related to.
For Apple in 2017, note 4 to the financial statements tell us that “Amortization expense
related to acquired intangible assets was $1.2 billion in 2017”.
So is that big or small in comparison with other companies?
Well, let’s look at some of the other companies in the top 10
of public corporations by market capitalization.
Alphabet Inc (the parent company of Google) had an amortization expense relating to purchased
intangible assets of $796 million for 2017.
Johnson & Johnson had intangible asset amortization expense in 2017 of $3 billion.
Microsoft recorded intangible assets amortization expense of $1.7 billion for fiscal year 2017,
and amortization of capitalized software of $55 million.
Two conclusions from this overview: ONE it is not unusual for large multinational companies
to have amortization expenses of $1 billion or more per year, and TWO most of the amortization
expenses seem to have something to do with intangible assets.
In order to grasp the concept of amortization, it is important to realize that amortization
is the “sister” of depreciation.
Depreciation is the accounting process of allocating the cost of tangible assets to
current expense in a systematic and rational manner in those periods expected to benefit
from the use of the asset.
For example, tangible assets like buildings, machines, and trucks get depreciated.
You buy a fixed asset for $100,000, expect to use it for 5 years, so you take $20,000
depreciation expense in each of those 5 years.
Amortization is very similar to depreciation, just change “tangible assets” in the definition
for “intangible assets”: amortization is the accounting process of allocating the
cost of intangible assets to current expense in a systematic and rational manner in those
periods expected to benefit from the use of the asset.
So while tangible assets get depreciated, intangible assets like patents, licenses,
software, and capitalized research and development get amortized.
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Now that we know the definition of amortization, how do we account for it?
Let’s return to the example of Apple Inc.
On the balance sheet of Apple Inc, there is an asset line item called acquired intangible assets.
For the amortization expense journal entry in 2017, you debit amortization expense in
the income statement, and credit the accumulated amortization contra-account
on the balance sheet.
If you sum the gross amount of acquired intangible assets with accumulated amortization, you
get to the net carrying amount of acquired intangible assets.
Let’s look at those numbers specifically.
Apple discloses in the annual report that the Company’s acquired intangible assets
with definite useful lives primarily consist of patents and licenses.
At the end of its fiscal year 2017, the gross carrying amount of acquired intangible assets
was $7.6 billion, the accumulated amortization (which is the sum of the amortization expense
amounts booked on the contra-account over the years) was $5.3 billion,
so the net carrying amount was $2.3 billion.
For investors or analysts that want to understand the impact of amortization expense on the
financial statements of future years, companies publish the expected annual amortization expense
based on the current net carrying amount.
For Apple Inc, as of September 30, 2017, the remaining weighted-average amortization period
for acquired intangible assets is 3.4 years.
$948 million of the $2.2 billion net carrying amount of definite-lived and amortizable acquired
intangible assets will impact the company’s financial results of fiscal year 2018, $505
million in 2019, etcetera.
I hope this explanation of the finance term amortization was useful for you!
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