Not all of your company’s assets can necessarily be seen. When you invest in new delivery vans or machinery for a factory, those are things you can see and touch. But what happens when you invest in a new website design or software licenses for your employees? Don’t those things have value, too?
In this article we will explain how and when to use amortisation to track the value of assets in your business.
What is amortisation?
When a company invests in any new asset, it will have a value that is considered to be a part of the company’s overall assets.
Amortisation is an accounting process that is used to track the declining value of non-physical assets, which can be written off gradually over their useful lifetime. It is usually shown as an operating expense on your company's financial statement, which has the effect of reducing gross profit and tax liability over an extended period.
Lixir Drinks recently invested in a brand refresh, which included creating new logos, a new website and commissioning a design for a bespoke bottle for its tonic and mixer drinks. “Switching from a stock glass bottle to a bespoke bottle helps to set us apart from other smaller makers in our market,” explains Jordan Palmer, the company’s co-founder. “We also had an agency create new brand guidelines and updated our graphics and labels.”
The bottle design, graphics and website are new intellectual property, which is owned by the business as an intangible asset. This asset is amortised over a period of five years, explains Palmer. “The design update will span that period and amortisation means we can capture the value of that IP, and treat it as an asset over that time,” he says.
Amortisation vs depreciation
Depreciation works in the same way as amortisation but relates to physical assets. This will often include assets like vehicles, computers and other machinery. “To put it simply, if you can kick it, it depreciates; if you can’t kick it, then it amortises,” says Clare Bowen, a director at financial advisory firm Monahans.
Like many businesses, Lixir is also investing heavily in online and cloud-based services, from accounting software to HR administration systems and marketing databases. Amortisation allows these assets to be accounted for, just as depreciation is used to account for physical assets.
“Increasingly, I think companies aren’t investing in physical assets as much,” says Palmer. “We’re in London and we rent flexible space, and we aren’t looking to invest in buildings or vehicles in a significant way.”
While both amortisation and depreciation help lessen the impact of an investment on long-term company accounts, it is sometimes the upfront impact on cash flow from a large capital outlay that can be more of a concern for small businesses. The flexible payment terms of an American Express® Business Gold Card can help reduce this initial impact of a major purchase, giving you up to 54 days to clear your balance¹. In addition, for every pound you spend, you’ll get 1 Membership Rewards® point that you can use on a wide range of gifts and perks for your team².
Types of amortisation
Amortisation is typically applied to intangible assets or to loans.
It is also worth noting that in the US, amortisation is sometimes used to refer to the amount that an asset has depreciated – an asset that was originally purchased at $1,000,000 that is currently valued at $800,000 is said have an ‘amortisation value’ of $200,000. However, this use of amortisation is not generally used in the UK.
Intangible asset amortisation
As discussed above, a business will use amortisation to track the decreasing value of an intangible asset over a long-term period of up to ten years.
For example, Company A invests £50,000 in a new database of customer leads for prospecting. It is expected that the database will be used for the next three years. Amortisation is used to calculate the value of the asset over its useful life (three years), which will reduce at a steady rate. There is not expected to be any residual value at the end of this period, which you might expect for a physical asset like a van or a printer.
Loan Amortisation
Businesses often take on external loans and financing to support growth. Loans will be for a set amount, to be repaid over a set period of time.
For example, Company B takes out a loan of £100,000 to invest in a new warehouse. The loan is to be repaid at £2,500 per month for 40 months. During this period, the business is building up equity in the warehouse at the same time it is paying off the loan. At the end of the amortised period (40 months), the company owns the warehouse outright.
So, in this example, amortisation accounts for what proportion of the loan is owned at any given time.
How to calculate amortisation
To calculate amortisation, you’ll need to know the value of an asset and the likely useful life of that asset. The rate of amortisation is typically steady, meaning the value of the asset is written off at a set amount for each accounting period.
“There are no hard and fast rules when it comes to the useful life of an intangible asset, but you can talk to your accountant for examples and guidance on the value,” advises Bowen. “It will be based on the value of that asset to your business and at what time it no longer contributes value because it has been replaced or has become obsolete.”
If a company amortises an asset, there will be a schedule attached to the amortisation. In the example below, we can see how Company C amortises its software licensing spend:
- Upfront cost: £50,000
- Amortisation period: 10 years
- Amortisation per year: 50000/10 = £5,000 per year
After 10 years the asset has been fully written down. In general, this is the longest period an asset will be amortised over, says Bowen. “As a guideline you might expect big software to be used over 10 years, while a website refresh might only be three to five years, because it’s likely to be refreshed more quickly,” she adds.
Indeed, Lixir Drinks chose a five-year period to amortise its brand refresh as this is the anticipated useful life of the assets involved. After five years, the company expects that it will need to reinvest in a fresh website and potential new branding.
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