Accumulated amortization is the total sum of amortization expense recorded for an intangible asset. In other words, it’s the amount of costs that have been allocated to the asset over its useful life.
A lot of people confuse amortization with depreciation. Although both are similar concepts, depreciation is used for physical assets like fixed assets whereas amortization is used for intangible assets like patents.
Both Fixed assets and intangible assets are capitalized when they are purchased and reported on the balance sheet. No costs are initially recorded on their purchase dates. Instead, the assets’ costs are recognized ratably over the course of their useful life. This cost allocation method agrees with the matching principle since costs are recognized in the time period that the help produce revenues.
The accumulated amortization account is a contra asset account that is used to lower the book value of the intangible assets reported on the balance sheet at historical cost. Accumulated depreciation is usually presented after the intangible asset total and followed by the book value of the assets. This presentation shows investors and creditors how much cost has been recognized for the assets over their lives. Conversely, it also gives outside users an idea of the amount of amortization costs that will be recognized in future periods.
Let’s look at an example.
Alan’s Engineering is a company that creates software packages for engineering firms. It has numerous register trademarks, copyrights, and patents for its work. A new project costing $20,000 was completed this year and obtained a patent with 20-year life.
At the end of the first year, Alan will debit amortization expense and credit accumulated amortization for $1,000 (total purchase price divided by useful life in years). Alan will make this journal entry every year to the record the current amortization expense and cumulative expense over the life of the asset. The current expense will be reported on the income statement and the updated accumulated total will be reported on the balance sheet each year.