Amortization

Amortization occurs when the value of an intangible asset - i.e. customer lists, licensing agreements, service contracts, computer software and etc - is reduced over a specific time period, which is usually over the asset's estimated useful life.

A good way to think of this is to consider amortization to be the cost as the asset is consumed or used up while generating sales or profits.

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Major issues of the amortization process include useful life, residual value and the allocation method, the last of which can be on a straight-line basis that is mostly straightforward.

A rule of thumb on this is to amortize an asset over time if the benefits from it will be realized over a time period of several years.

With a short expected duration, it is probably best and most efficient to expense the cost through the income statement.

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Also, amortization refers to capitalizing the value of an intangible asset over time.

Depreciation, on the other hand, is meant to refer more to capitalizing the value of a tangible asset over time; for example, a piece of equipment, a vehicle or office furniture that a company might purchase.

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