Amortization of Intangible Assets
Amortization is like depreciation, except that amortization refers to intangible assets, or assets that do not physically exist, such as a brand name. Amortization directly reduces the asset on the balance sheet. Goodwill cannot be amortized, even if it is a kind of intangible assets.
Depreciation and amortization are income tax deduction but does not affect cash flows from operating activities. Therefore, both expenses appear in the income statement, even though they are non-cash expenses. To recap depreciation (of our freezer), visit Capital Expenditures and Depreciation.
After we acquired Café 95 and recorded $55,000 in Intangible Assets, we need to write off the value of Intangible Assets over their lifetime. Let say, we assume 5 years for the lifetime of the Intangible Assets.
| Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | |
|---|---|---|---|---|---|
| Intangible Assets | 55,000 | 44,000 | 33,000 | 22,000 | 11,000 |
| Amortization in the Income Statement | 11,000 | 11,000 | 11,000 | 11,000 | 11,000 |
| Book Value | 44,000 | 33,000 | 22,000 | 11,000 | 0 |
In our Balance Sheet, value of the Intangible Assets will be reduced by $11,000 and become $44,000.
| Balance Sheet | Year 1 | Year 2 | Explanation |
|---|---|---|---|
| Assets | |||
| Current Assets | |||
| Cash | 30,000.00 | (57,794.00) | |
| Inventory | 0.00 | 21,500.00 | |
| Accounts Receivable | 0.00 | 44,200.00 | |
| Prepaid Expenses | 0.00 | 16,000.00 | |
| Short-Term Investments | 0.00 | 0.00 | |
| Total Current Assets | 30,000.00 | 23,906.00 | |
| Long Term Assets | |||
| Property, plant and equipment | 0.00 | 39,000.00 | |
| Intangible Assets | 0.00 | 44,000.00 | $55,000 – $11,000 = $44,000 |
| Goodwill | 0.00 | 25,000.00 | |
| Total Long Term Assets | 0.00 | 108,000.00 | |
| Total Assets | 30,000.00 | 131,906.00 | |
| Liabilities & Equity | |||
| Current Liabilities | |||
| Accounts Payable | 0.00 | 14,000.00 | |
| Deferred Revenue | 0.00 | 11,500.00 | |
| Total Current Liabilities | 0.00 | 25,500.00 | |
| Long Term Liabilities | |||
| Borrowings | 0.00 | 45,000.00 | |
| Total Long Term Liabilities | 0.00 | 45,000.00 | |
| Toal Liabilities | 0.00 | 70,500.00 | |
| Equity | 30,000.00 | 61,406.00 | |
| Total Liabilities & Equity | 30,000.00 | 131,906.00 |
It should be noted that Amortization is a non-cash expense, so it is an adjustment in the Cash Flow Statement. It reduces the company’s taxes, but it costs the company nothing in cash. As a result, the company’s cash balance increases.
| Cash Flow Statement | Year 1 | Year 2 |
| Cash flows from operating activities | ||
| Net Income | 28,804.00 | 39,406.00 |
| Depreciation | 0.00 | 6,000.00 |
| Amortisation of intangible assets | 11,000.00 | |
| (Gains) / Losses on disposal of quoted shares | 0.00 | (1,000.00) |
| PP&E written off | 0.00 | 3,000.00 |
| Inventories written off | 0.00 | 500.00 |
| Receivables written off | 0.00 | 800.00 |
| Changes in working capital | ||
| (Increase)/Decrease in Inventory | 0.00 | (22,000.00) |
| (Increase)/Decrease in Accounts Receivable | 0.00 | (45,000.00) |
| (Increase)/Decrease in Prepaid Expenses | 0.00 | (16,000.00) |
| Increase/(Decrease) in Accounts Payable | 0.00 | 4,000.00 |
| Increase/(Decrease) in Deferred Revenue | 0.00 | 11,500.00 |
| Net cash from operating activities | 28,804.00 | (7,794.00) |
| Cash flows from investing activities | ||
| Capital Expenditures | 0.00 | (18,000.00) |
| Acquisition of quoted shares | 0.00 | (10,000.00) |
| Disposal of quoted shares | 0.00 | 11,000.00 |
| Acquisition of Café 95 | 0.00 | (180,000.00) |
| Net cash from investing activities | 0.00 | (197,000.00) |
| Cash flows from financing activities | ||
| Proceeds from bank borrowings | 0.00 | 50,000.00 |
| Repayment of bank borrowings | 0.00 | (5,000.00) |
| Shares Issuance | 0.00 | 10,000.00 |
| Dividends Issued | 0.00 | (8,000.00) |
| Shares Repurchase | 0.00 | (10,000.00) |
| Net Cash from financing activities | 0.00 | 37,000.00 |
| Net Change in Cash | 28,804.00 | (167,794.00) |
As Amortization reduces the company’s taxes, we must record it in the Income Statement. Net Income decreases due to this Amortization expense.
| Income Statement | Year 1 | Year 2 |
| Revenue | 200,000.00 | 280,000.00 |
| Cost of Sales | (110,000.00) | (150,000.00) |
| Gross Profit | 90,000.00 | 130,000.00 |
| Selling and marketing expenses | (3,000.00) | (7,000.00) |
| Administrative expenses | (50,000.00) | (50,000.00) |
| Operating Expenses | (53,000.00) | (57,000.00) |
| Depreciation | 0.00 | (6,000.00) |
| Amortisation of intangible assets | 0.00 | (11,000.00) |
| Operating Profit | 37,000.00 | 56,000.00 |
| Other Income / (Expenses) | 900.00 | 900.00 |
| Interest Income / (Expenses) | 0.00 | (1,750.00) |
| Gains / (Losses) on disposal of quoted shares | 0.00 | 1,000.00 |
| PP&E written off | 0.00 | (3,000.00) |
| Inventories written off | 0.00 | (500.00) |
| Receivables written off | 0.00 | (800.00) |
| Profit Before Tax | 37,900.00 | 51,850.00 |
| Income tax expense (24%) | (9,096.00) | (12,444.00) |
| Net Income | 28,804.00 | 39,406.00 |
Impact of Amortization of Intangible Assets to the Financial Statements in a Glance
