Amortisation is an accounting term that can apply to certain business assets and loans. Usually used for intangible assets like patents, copyrights and trademarks, amortisation spreads the cost of the asset over the time that it’s used. It’s a way to measure the ongoing benefit of an asset against the cost and reduce tax liability.
In this guide, we look at different types of amortisation, the reasons for using this accounting method, and the types of assets that can be amortised.
What is amortisation?
Amortisation means spreading a cost out over time; for example, loan repayments. It can also be used in accounting to claim back some of the value of an intangible asset over the years it’s used.
With an amortised loan, the buyer makes regular payments that are applied to both the principal and interest. At first, repayments are weighted towards repaying interest, but as the loan decreases, the balance shifts and the bulk of repayments goes toward the principal.
What are the two types of amortisation?
The two types of amortisation are known as ‘straight-line’ and ‘reducing balance’. In Australia, these are sometimes called prime cost and diminishing value amortisation.
Here’s how they work:
Straight-line amortisation
Straight-line amortisation involves dividing the cost of an asset equally across its expected life, with a portion of the cost listed as an expense in each tax period. For example, if an asset costs $20,000 and could be used for ten years, your accountant would list a $2000 expense for the asset each year.
In New Zealand, straight-line amortisation is used for intangible assets with a fixed cost, while the diminishing value method is used for those with an undefined cost.
Reducing balance amortisation
Reducing balance amortisation, sometimes called ‘declining balance’ or ‘diminishing value,’ reflects that the value of an asset declines over time. Instead of spreading the cost evenly over the useful period, reducing balance amortisation assigns a higher proportion of the cost early on, with progressively smaller amounts claimed over the life of the asset.
Why do businesses use amortisation?
Businesses use amortisation for several reasons. The benefits include:
Assigning expenses to the correct tax period.
Building an accurate picture of the company’s financial position.
Complying with tax regulations.
Amortisation vs depreciation: what is the difference?
The difference between amortisation and depreciation is the type of asset being claimed:
Amortisation is generally used for intangible assets like patents, copyrights, goodwill and intellectual property.
Depreciation is used to calculate the decreasing value of a tangible asset with a fixed cost like a company vehicle, real estate or machinery.
What assets can be amortised?
Assets with a finite lifespan and defined cost can generally be amortised. In Australia, this includes patents, copyrights, franchises, trademarks, software licences and customer lists.
In New Zealand, you can also claim the cost of creating internally generated assets like business processes and internal software.
What assets cannot be amortised?
Assets without a set period of usefulness or a definable cost cannot be amortised. For example, customer goodwill or reputation, while valuable, can’t generally be amortised as they don’t have fixed endpoints or a measurable cost.
What is amortisation of loans?
Amortisation of loans is a repayment structure that requires regular, equal loan repayments for a set period.
At first, most of each repayment goes toward interest accrued on the loan, with the remainder paying off the principal. Over time, as the loan decreases, more of the repayment is put towards the principal. Amortisation is a common loan structure, often used for mortgages, car loans, business loans and personal bank loans.
How to calculate loan amortisation
To calculate amortisation, multiply the loan amount by the interest rate. Divide by 12 to get the amount of interest paid monthly, then subtract that from the monthly payment. Whatever remains goes toward the principal.
Example: a home loan of $500,000 with an interest rate of 5% and monthly payments of $2,500
In the first month, the calculations would look like this:
$500,000 X 5% = total interest of $25,000
$25,000 divided by 12 = monthly interest of $2,083
$2,500 - $2,083 = $417 put toward the principal
In month 2, the calculations would look like this:
$499,583 X 5% = total interest of $24,979.15
$24,979.15 divided by 12 = monthly interest of $2,081
$2,500 - $2081 = $419 put towards the principal
In month 3, the calculations would look like this:
$499,164 X 5% = total interest of $24,958.20
$24,958.20 divided by 12 = monthly interest of $2,079
$2,500 - $2,079 = $421 put towards the principal
While the difference is tiny, as the months pass, the principal steadily decreases and a smaller proportion of the repayment goes toward interest.
What is amortisation of intangible assets?
Amortisation of intangible assets is a way for businesses to spread the cost-benefit of an asset over time. Instead of claiming the entire cost of an asset in the year it is purchased, the expense is spread over the expected lifespan of the asset. This means it can offset your tax liability for a longer period and help your business track the value against the cost.
How to calculate a straight-line amortisation rate
Calculating straight-line amortisation is relatively simple:
Calculate the value of the asset.
Estimate the period of use – if it has a set end-date, use that.
Divide the value by the number of years of use to find the amount that can be recorded.
Amortisation: FAQs
Do you pay tax on amortisation?
You don’t pay tax on amortisation. It can be a way of reducing your tax liability by claiming the cost of an asset over time. Instead of claiming the full expense for an intangible asset like a patent or copyright when it’s implemented, you spread the cost over the years of use, claiming it as a business expense for the years that the asset is in use.
What happens when an asset is fully amortised?
‘Fully amortised’ means that the cost of the asset has been allocated as a business expense and claimed on your tax return for a specific number of years. In most cases, a fully amortised asset has reached the end of its useful life and no longer has value to the company.
Should you use amortisation for your business?
You should use amortisation for your business if you purchase eligible assets and use them over time. Amortisation helps you measure the true cost of an asset against its value, and also reduces your tax bill.
Amortisation, business accounting and you
Like many accounting concepts, amortisation can be difficult for non-accountants to understand. With MYOB’s accounting software, you can track business purchases, manage loans, and record profit and loss balances without time-consuming manual calculations or complex repayment schedules.
With up-to-date accounting information on hand, it’s much easier to generate accurate tax returns and reduce your tax liability through amortisation or other methods. MYOB also provides automatic compliance with local tax legislation, so you can keep up with complex local rules about intangible assets and depreciation rates.
Ready to change the way you manage your business accounting? Get started today!
Disclaimer: Information provided in this article is of a general nature and does not consider your personal situation. It does not constitute legal, financial, or other professional advice and should not be relied upon as a statement of law, policy or advice. You should consider whether this information is appropriate to your needs and, if necessary, seek independent advice. This information is only accurate at the time of publication. Although every effort has been made to verify the accuracy of the information contained on this webpage, MYOB disclaims, to the extent permitted by law, all liability for the information contained on this webpage or any loss or damage suffered by any person directly or indirectly through relying on this information.
MYOB is not a registered entity pursuant to the Tax Agent Services Act 2009 (TASA) and therefore cannot provide taxation advice to clients. If you have a query concerning taxation including filing your BAS return or annual tax statements then you should consult with your accountant or other registered tax adviser.