What is amortization?

Amortization is an accounting method for allocating the cost of intangible assets over their economic life. Unlike depreciation, which applies to tangible assets, amortization is used specifically to reduce the value of intangible assets such as patents, trademarks, goodwill, and software.

The Difference Between Amortization and Depreciation

Many people confuse amortization with depreciation, but there are important differences between these two accounting concepts.

Main differences:

Aspect	Amortization	Depreciation
Asset type	Intangible assets	Tangible assets ( fixed assets )
Examples	Patents, goodwill, software	Machines, buildings, cars
Methods	Linear method (mainly)	Linear, balance method, production method
Residual value	Usually zero	May have residual value
Accounting standard	NGRS/IFRS	NGRS/IFRS

Types of Intangible Assets That Are Amortized

Not all intangible assets are amortized. Some have indefinite lives and are tested for impairment instead.

Assets that are Depreciated:

• Patents: Protect inventions for a specific period of time (usually 20 years)
• Copyright: Provides exclusive right to use creative work
• Software: Purchased or developed software for internal use
• Customer contracts: The value of existing customer relationships
• Non-compete agreements: Agreements that restrict competition

Assets that are NOT Depreciated:

• Goodwill: Tested annually for impairment
• Trademarks with indefinite useful lives: Tested for impairment
• Land rights: May have an indefinite lifespan

Amortization methods

The most commonly used method of amortization is the straight-line method , but several approaches exist depending on the nature of the asset.

1. Straight Line Amortization

This is the most common method where the cost is distributed evenly over the life of the asset.

Formula: Annual amortization = ( Acquisition cost - Residual value) ÷ Life in years

Example: - Patent acquired for NOK 500,000 - Lifespan: 10 years - Residual value: 0 kr - Annual amortization: 500,000 ÷ 10 = 50,000 NOK

2. Accelerated Amortization

Used when the asset provides greater benefit in the early years.

3. Unit-Based Amortization

Based on actual usage or production, often used for software based on the number of users.

Accounting for Amortization

Amortization is accounted for in the same way as depreciation, but affects intangible assets on the balance sheet.

Accounting example:

When acquiring a patent (500,000 NOK):

 Debet: Immaterielle eiendeler 500 000
 Kredit: Bank 500 000

For annual amortization (NOK 50,000):

 Debet: Amortiseringskostnad 50 000
 Kredit: Akkumulert amortisering 50 000

Practical Examples from Norwegian Industry

Let's look at how amortization works in practice through concrete examples.

Example 1: IT Company

Situation: An IT company purchases a software license for NOK 1,200,000 with a 4-year lifespan.

Calculation: - Annual amortization: 1,200,000 ÷ 4 = 300,000 NOK - Monthly amortization: 300,000 ÷ 12 = 25,000 NOK

Amortization schedule:

Year	Opening balance	Amortization	Closing balance
1	1,200,000	300,000	900,000
2	900,000	300,000	600,000
3	600,000	300,000	300,000
4	300,000	300,000	0

Example 2: Pharmaceutical Company

Situation: A pharmaceutical company has a patent worth 2,000,000 NOK with 8 years of remaining life.

Calculation: - Annual amortization: 2,000,000 ÷ 8 = 250,000 NOK

Amortization and Tax Considerations

In Norway, the tax treatment of amortization follows specific rules that may differ from the accounting treatment.

Tax Rules:

• Goodwill: Can be depreciated over 5 years for tax purposes
• Patents: Follows the actual lifetime
• Software: Typically 3-5 years depreciation period
• Research and development: Special rules for R&D costs

For more information on tax depreciation, see our guide on share capital which also covers equity-related topics.

Amortization in the Annual Accounts

Amortization affects both the income statement and the balance sheet, and must be presented correctly in the annual accounts.

Presentation in the Income Statement:

• Amortization costs are recorded as operating expenses.
• Can be specified separately or included in "Depreciation"
• Negatively affects operating profit

Presentation in Balansen:

• Intangible assets are shown at acquisition cost.
• Accumulated amortization is deducted (as a negative entry)
• Net book value is shown in the balance sheet

Impairment and Write-downs

Even though assets are amortized according to plan, situations may arise where their value falls faster than expected.

Indicators of Impairment:

• Technological changes that make the asset obsolete
• Changes in market conditions
• Legal changes affecting the value of the asset
• Competition that reduces the asset's utility

Impairment test:

If there are indications of impairment, the company must:

1. Calculate recoverable amount: The higher of fair value less costs to sell and value in use
2. Compare with book value: If book value is higher, it should be written down
3. Accounting for impairment: As an extraordinary expense

International Accounting Standards

For companies that follow IFRS, specific rules apply for amortization of intangible assets.

IAS 38 - Intangible Assets:

• Recognition criteria: The asset must be controllable and provide future economic benefits.
• Measurement: At cost less accumulated amortization and impairment
• Amortization period: Over the useful life of the asset, maximum 20 years if not determinable
• Method: Should reflect how economic benefits are consumed

Digitization and Modern Amortization

With increased digitalization, the nature of intangible assets that must be amortized also changes.

New Types of Intangible Assets:

• Cloud-based software solutions: SaaS subscriptions and licenses
• Digital platforms: Development costs for apps and websites
• Data and Algorithms: Valuable Datasets and AI Models
• Digital customer relationships: CRM systems and customer data

Challenges of Modern Amortization:

• Shorter lifespan: Technology becomes obsolete quickly
• Uncertain value: Difficult to estimate future utility
• Complex measurement: Challenges in separating development costs from operations

Best Practices for Amortization

To ensure correct amortization, companies should follow established best practices.

Recommendations:

1. Document lifespan estimates: Keep detailed records of how lifespan is determined
2. Review regularly: Assess whether lifetime estimates are still relevant
3. Consistent method: Use the same amortization method for similar assets
4. Monitor impairment: Be aware of indicators that may require impairment
5. Professional judgment: Consult accounting experts for complex situations

Relationship to Other Accounting Concepts

Amortization is related to several other important accounting concepts that are essential to understanding the overall picture.

Related Concepts:

• Depreciation : For tangible assets
• Impairment: When the value of assets falls below their book value
• Goodwill: Special type of intangible asset that is not amortized
• Capitalization: When costs are recorded as an asset instead of an expense

For businesses that work with limited liability companies, it is important to understand how amortization affects the company's financial position and reporting to shareholders.

Conclusion

Amortization is a fundamental accounting principle that ensures that the cost of intangible assets is allocated fairly over their economic lives. By understanding the different methods, accounting treatment, and practical applications, companies can ensure accurate financial reporting and make better decisions about investments in intangible assets.

Proper amortization is not only an accounting requirement, but also a tool for understanding the true cost of owning and using intangible assets in the business.