Amortisation is the systematic allocation of the cost of an intangible asset over its estimated useful life. It is the intangible equivalent of depreciation, which applies to tangible fixed assets. Both methods serve the same purpose: ensuring that the cost of a long-lived asset is matched to the periods in which it generates economic benefits, in line with the matching principle.
Section 1: What Are Intangible Assets?
An intangible asset is an identifiable, non-monetary asset without physical substance. Under FRS 102 Section 18, an intangible asset is recognised when:
- It is probable that future economic benefits will flow to the entity
- The cost can be measured reliably
1.1 Common Intangible Assets
| Intangible asset | Description | Typical useful life |
|---|---|---|
| Goodwill | The excess of purchase price over fair value of net assets in a business combination | Up to 10 years (FRS 102) |
| Patents | Legal protection for inventions | Life of patent (typically up to 20 years) |
| Trademarks | Registered brand names and logos | Registration period or economic life |
| Software | Purchased or internally developed computer programs | 3 to 7 years |
| Customer lists | Acquired lists of customers with contractual relationships | 3 to 10 years |
| Licences and franchises | Rights to operate or use intellectual property | Term of the agreement |
| Development costs | Costs meeting the capitalisation criteria | Project-specific |
1.2 Internally Generated Intangibles
FRS 102 prohibits the recognition of internally generated goodwill, brands, mastheads, customer lists and similar items. However, development costs may be capitalised if the entity can demonstrate that the project will be completed, the asset will generate future economic benefits, and the costs can be measured reliably.
Research costs are always expensed as incurred. This distinction is important for technology and pharmaceutical companies that invest heavily in R&D.
Section 2: How Amortisation Works
2.1 The Calculation
The basic formula for straight-line amortisation is identical to straight-line depreciation:
Annual amortisation = (Cost - Residual value) / Useful life
For most intangible assets, the residual value is assumed to be zero because there is typically no market for a used intangible asset at the end of its useful life.
2.2 Example: Purchased Software
A UK company purchases accounting software for £35,000 and expects to use it for five years before replacing it.
Annual amortisation = £35,000 / 5 = £7,000 per year
| Year | Opening value | Amortisation | Closing value |
|---|---|---|---|
| 1 | £35,000 | £7,000 | £28,000 |
| 2 | £28,000 | £7,000 | £21,000 |
| 3 | £21,000 | £7,000 | £14,000 |
| 4 | £14,000 | £7,000 | £7,000 |
| 5 | £7,000 | £7,000 | £0 |
2.3 Example: Acquired Patent
A manufacturing company acquires a patent for £120,000. The patent has a remaining legal life of 15 years, but the company expects to benefit from it for only 10 years due to expected technological changes.
Annual amortisation = £120,000 / 10 = £12,000 per year
The useful life is the shorter of the legal life and the expected economic life.
Section 3: FRS 102 Requirements
3.1 Useful Life
Under FRS 102 Section 18.20, if an entity cannot make a reliable estimate of the useful life of an intangible asset, the life shall not exceed 10 years. This is a significant departure from IFRS, which allows indefinite useful lives for certain intangibles.
3.2 Amortisation Method
FRS 102 Section 18.22 states that the amortisation method should reflect the pattern in which the asset’s future economic benefits are expected to be consumed. If that pattern cannot be determined reliably, the straight-line method shall be used.
3.3 Review of Estimates
The useful life and amortisation method must be reviewed at least at each reporting date. If expectations have changed, the estimates are revised prospectively (affecting future periods, not past ones).
3.4 Goodwill
Goodwill arising from a business combination is treated as an intangible asset under FRS 102 and must be amortised. Key requirements:
- Useful life must not exceed 10 years unless a longer period can be justified
- If the useful life cannot be estimated reliably, it is presumed to be 5 years
- Goodwill must also be assessed for impairment when indicators exist
This differs from IFRS, where goodwill is not amortised but instead tested for impairment annually.
Section 4: Amortisation and UK Tax
4.1 General Position
For corporation tax purposes, amortisation of intangible assets is generally an allowable deduction if the intangible asset was acquired or created on or after 1 April 2002. The tax relief broadly follows the accounting treatment.
4.2 Pre-2002 Intangibles
Intangible assets acquired before 1 April 2002 (known as old assets) do not qualify for the intangible fixed assets regime. Instead, they may qualify for other forms of tax relief depending on their nature.
4.3 Goodwill and Customer-Related Intangibles
From 1 April 2019, the tax deduction for amortisation of goodwill and customer-related intangible assets acquired from third parties is limited to a fixed rate of 6.5% of cost on a straight-line basis, regardless of the accounting amortisation rate.
| Asset type | Tax deduction |
|---|---|
| Goodwill (post-April 2019 acquisitions) | 6.5% straight-line |
| Customer-related intangibles (post-April 2019) | 6.5% straight-line |
| Other intangibles (post-April 2002) | Follows accounting amortisation |
| Pre-April 2002 intangibles | Outside intangibles regime |
4.4 Deferred Tax
Where the accounting amortisation and tax deduction differ in timing, a deferred tax balance arises, similar to the timing differences created by depreciation and capital allowances.
Section 5: Amortisation vs Depreciation
| Feature | Amortisation | Depreciation |
|---|---|---|
| Applies to | Intangible assets | Tangible fixed assets |
| Common examples | Goodwill, patents, software | Buildings, vehicles, machinery |
| Residual value | Usually zero | Often has a residual value |
| FRS 102 section | Section 18 | Section 17 |
| HMRC treatment | Generally deductible (post-2002) | Not deductible; capital allowances claimed instead |
| Maximum useful life (if uncertain) | 10 years (FRS 102) | No maximum specified |
Both amortisation and depreciation are non-cash expenses that reduce reported profit without any cash leaving the business. Both are added back in the cash flow statement under the indirect method.
Section 6: Impairment of Intangible Assets
6.1 When to Test
FRS 102 Section 27 requires an impairment review when indicators suggest an intangible asset may be impaired. For goodwill, impairment testing is required whenever there are indicators of impairment.
6.2 Indicators of Impairment
- The asset’s market value has declined significantly
- The technology or market the asset relates to has changed adversely
- Revenue generated by the asset has fallen below expectations
- The legal or regulatory environment has changed
6.3 Recording Impairment
An impairment loss is recognised in the income statement and reduces the carrying value of the asset. Future amortisation is recalculated based on the revised carrying value and remaining useful life.
Section 7: Disclosure Requirements
Under FRS 102, entities must disclose for each class of intangible asset:
- The useful lives or amortisation rates used
- The amortisation methods applied
- The gross carrying amount and accumulated amortisation at the start and end of the period
- Additions, disposals and impairment losses during the period
- The line item in the income statement in which amortisation is included
For goodwill, the factors that contributed to the recognition of goodwill must also be described.
Section 8: Practical Considerations
8.1 Software Costs
UK businesses frequently need to decide whether software costs should be capitalised and amortised or expensed immediately. The key question is whether the expenditure creates a distinct asset with future economic benefits:
- Purchased software: Capitalised and amortised over its expected useful life
- Cloud-based subscriptions (SaaS): Generally expensed as incurred, since the business does not control the underlying asset
- Internally developed software: Capitalised only if development costs meet the FRS 102 recognition criteria
8.2 Website Costs
Costs of developing a website are capitalised and amortised if the website generates revenue or provides other economic benefits. Costs of maintaining or operating the website are expensed as incurred.
8.3 Intangible Asset Register
Similar to a fixed asset register for depreciation, businesses should maintain an intangible asset register tracking:
- The asset’s description and cost
- Acquisition date
- Useful life and amortisation method
- Accumulated amortisation and carrying value
- Any impairment losses
This register supports the balance sheet, trial balance and audit process.
Understanding amortisation is essential for accurately reporting the value of intangible assets in UK financial statements and for calculating the correct tax deduction on these increasingly important business assets.