What is Amortization

In any organization or business,  there are office equipment, properties, building, vehicles, machinery and tools that are used for years in office or production and it is needful to calculate their useful life to announce the management about date of exchange them with a new one, and so it is important for management to know about charges of these exchanges.

Amortization refer to intangible assets but for tangible assets like office furniture, the term Depreciation will be used

Depreciation example of a chair

For Example: When a table is new, it has 100% of its purchase price value, after one year, its value is 80% of its purchase price, after 2nd year, , its value is 60% of its purchase price, … and to the end that is 10%

life Percentage of amortization
Life percentage of amortization

Amortization example

For example you established a print center and you purchased a special license for a print software for $ 110,000 regard to printer system’s manufacturer manual, this license of print system could be used for maximum  30,000 hours running.You will use this print system for 8 hours per day

30000 (All hours of print life ) / 8 hours using per day = 3750 days

3750 days is useful life of this printer license for your company regard to 8 hours using per day

3750 days = 10 years

Maximum life will be : 10 years
So that, every year, $3000 value will be reduced of its useful life

So after this time, you should buy a new one

Therefore you have an expense account in your office
It is $3000 per year for print system
Or
$250 per month

Reduced useful life of printer hardware (tangible assets) named “Depreciation”.

Reduced useful life of printer software (Intangible assets) named “Amortization”.

For above example monthly Amortization account will be debit for $250.

Next Read: Journal entry of Amortization

Goodwill

Business executives used the term Goodwill in a variety of meanings before it became part of accounting terminology. One of the most common meanings of goodwill in a non accounting sense concerns:

The benefits derived from a favorable reputation among customers.

Definition of  ” Goodwill “

Goodwill
To accountants, “goodwill” has a very specific meaning not necessarily limited to customer relations. It means the present value of future earnings in excess of the normal return on net identifiable assets. Above-average earnings may arise not only from favorable customer relations but also from such factors as superior management, manufacturing efficiency, and weak competition.

The phrase normal return on net identifiable assets requires explanation. ‘Net assets’ means the owners’ equity in a business, or assets minus liabilities. Goodwill, however, is not an identifiable asset.

A clear example: Goodwill has been made from sentence: “it will be good” !.

for example a brand name is one of goodwill because a good brand name will cause good sales for a company.

The existence of  Goodwill is implied by the ability of a business to earn an above-average return; however, the cause and precise dollar value of goodwill are largely matters of personal opinion. Therefore, net identifiable assets mean all assets except goodwill, minus liabilities.

A normal return on net identifiable assets is the rate of return which investors demand in a particular industry to justify their buying a business at the fair market value of its net identifiable assets. A business has goodwill when investors will pay a higher price because the business earns more than the normal rate of return.

For more info: How to do journal entry

External Reference: Investopedia