What Is Unamortized Cost and How Is It Calculated?

Unamortized cost is the portion of an intangible asset’s original price that has not yet been allocated to expense. It represents the remaining value of an asset that is expected to provide future economic benefits to a company. This figure is a snapshot in time, reflecting the asset’s book value after accounting for its use to date.

The Foundation of Amortization

Amortization is the accounting process of systematically allocating the cost of an intangible asset over its useful life. This practice is based on the matching principle, which states that expenses should be recognized in the same period as the revenues they help generate. By spreading the cost, a business avoids recording a large, front-loaded expense for an asset that contributes to operations for many years.

This process applies to intangible assets with a finite, or limited, useful life. Common examples of such assets include:

• Patents that protect inventions
• Copyrights that cover creative works
• Trademarks that safeguard brand names and logos
• Franchise agreements
• Certain capitalized costs, like loan origination fees

The determination of an asset’s useful life is an estimate based on legal, contractual, or functional factors. For instance, a patent’s useful life for accounting purposes might be its legal term of 20 years, or shorter if technology is expected to make it obsolete sooner. The method used should reflect the pattern in which the economic benefits are consumed. If this pattern cannot be reliably determined, the straight-line method is used.

Calculating the Unamortized Cost

The calculation of unamortized cost tracks the reduction of an asset’s value. The formula is: Unamortized Cost = Initial Cost – Accumulated Amortization. The initial cost is the full purchase price of the intangible asset. Accumulated amortization is the sum of all amortization expense recorded for the asset from its acquisition to the calculation date.

To illustrate, consider a technology company that acquires a patent for an initial cost of $50,000. The company determines the patent has a useful life of 10 years and will have no residual value. Using the straight-line method, the annual amortization expense is calculated by dividing the initial cost by the useful life, which results in $5,000 per year ($50,000 / 10 years).

At the end of the first year, the accumulated amortization is $5,000, and the unamortized cost of the patent is $45,000 ($50,000 – $5,000). After the second year, accumulated amortization is $10,000. The unamortized cost at the end of Year 2 is then $40,000 ($50,000 – $10,000).

This calculation continues annually over the asset’s life. For example, at the end of the fifth year, the accumulated amortization would total $25,000 (5 years x $5,000). The unamortized cost would therefore be $25,000 ($50,000 – $25,000).

Presentation on Financial Statements

The figures from the amortization process are reported on two separate financial statements. The unamortized cost, representing the net book value of the intangible asset, is presented on the balance sheet. It is classified as a long-term asset, as its benefits extend beyond one year.

Financial statements disclose the details in the notes or directly on the balance sheet. Using the previous example, at the end of Year 2, the balance sheet might show: “Patents, net of accumulated amortization of $10,000… $40,000.” U.S. Generally Accepted Accounting Principles (GAAP), under ASC 350, require disclosure of the gross carrying amount and accumulated amortization.

The amortization expense is reported on the income statement for the period. It is included within operating expenses, often under the “Selling, General, and Administrative” (SG&A) category. In our example, the company would report $5,000 in amortization expense on its income statement each year, which reduces the company’s operating and net income.

Accounting for Asset Disposal or Impairment

The accounting for an intangible asset changes if it is disposed of before its useful life ends. When an asset is sold, amortization expense is updated to the date of sale. A gain or loss is then calculated by comparing the cash proceeds from the sale to the asset’s unamortized cost. If cash received is greater than the unamortized cost, a gain is recognized; if less, a loss is recorded.

An impairment occurs when the fair value of an intangible asset drops below its unamortized cost, suggesting it will not generate the expected future economic benefits. GAAP, under ASC 360, requires companies to test these assets for impairment whenever events indicate the carrying amount may not be recoverable. For example, a new technology might render an existing patent less valuable.

If an asset is impaired, the company must recognize an impairment loss by writing down the asset’s book value to its current fair value. The amount of the write-down is recorded as an impairment loss on the income statement. This loss reduces the company’s net income.