What Is Straight-Line Amortization?
Discover a fundamental accounting method for consistently spreading asset costs and expenses over time, ensuring clear, predictable financial reporting.
Discover a fundamental accounting method for consistently spreading asset costs and expenses over time, ensuring clear, predictable financial reporting.
Amortization is an accounting method used to spread the cost of an intangible asset or a prepaid expense over its useful life. This systematic allocation helps businesses match expenses with the revenues they help generate, adhering to accounting principles. Among various methods, straight-line amortization is the most common and straightforward approach.
Straight-line amortization is a method that distributes the cost of an intangible asset evenly across its estimated useful life. This approach simplifies financial reporting by applying the same expense amount each period until the asset’s value is fully recognized. An intangible asset is a non-physical asset that holds value for a company for more than one year, such as patents or trademarks. The useful life of an intangible asset is the period over which it is expected to provide economic benefits. Unlike tangible assets, intangible assets typically do not have a salvage value, meaning they are not expected to have any remaining value at the end of their useful life for the original holder.
The calculation for straight-line amortization follows a simple formula: (Cost of Asset – Salvage Value) / Useful Life. Since intangible assets usually have no salvage value, the formula often simplifies to: Cost of Asset / Useful Life. For example, if a company acquires a patent for $60,000 with an estimated useful life of 10 years, the annual amortization expense would be calculated as $60,000 / 10 years, resulting in $6,000 per year. This $6,000 expense would be recorded consistently each year for the entire 10-year period.
Straight-line amortization primarily applies to intangible assets with a finite useful life. Common examples include patents, copyrights, trademarks, customer lists, and certain types of computer software. Under U.S. tax law, specifically Internal Revenue Code Section 197, many acquired intangible assets are amortized over a 15-year period using the straight-line method, regardless of their actual useful life. This includes assets like goodwill, covenants not to compete, and franchises. Prepaid expenses, such as prepaid insurance or rent, are also amortized using this method to spread their cost evenly over the period they cover.
Recording straight-line amortization involves specific entries in a company’s accounting records. The typical journal entry involves debiting “Amortization Expense” and crediting the specific intangible asset account, or sometimes an “Accumulated Amortization” account. This process systematically reduces the asset’s book value over its useful life. The impact of amortization is visible on both the income statement and the balance sheet. On the income statement, Amortization Expense is recognized, which reduces the company’s net income. On the balance sheet, the carrying value of the intangible asset is reduced by the accumulated amortization, reflecting its declining economic benefits over time.