What is Amortisation?

Amortisation is the accounting process of spreading the cost of an intangible asset over its estimated useful life. Intangible assets are non-physical assets that have value to the business -- common examples include purchased software, patents, trademarks, customer lists, licences, and goodwill arising from business acquisitions. The concept is identical to depreciation, but the term "amortisation" is used specifically for intangible assets.

For UK limited companies following FRS 102, intangible assets with a finite useful life must be amortised. If you cannot reliably estimate the useful life, a maximum of 10 years is assumed. Goodwill acquired in a business combination is also amortised over its useful life, with a maximum of 10 years if the life cannot be reliably estimated. This differs from international standards (IFRS), where goodwill is not amortised but tested for impairment annually.

The tax treatment of amortisation depends on the type of intangible asset and when it was acquired. For intangible assets acquired or created on or after 1 April 2002, the accounting amortisation charge generally is allowed as a tax deduction -- a significant difference from tangible assets, where depreciation is not allowable and must be replaced by capital allowances. However, there are exceptions and restrictions, particularly for goodwill acquired from related parties and for assets that existed before 2002. The rules are complex, and specific professional advice is usually needed.

Software is one of the most common intangible assets for small companies. If your company purchases bespoke software or a perpetual software licence, it is capitalised and amortised. However, annual software subscriptions (SaaS) are simply expensed each year and not capitalised. The distinction matters because capitalisation delays the expense over several years, while a subscription is an immediate deduction.

When you acquire an intangible asset, the cost is capitalised on your balance sheet. Each year, an amortisation charge is calculated and recorded as an expense on the P&L, reducing the asset's carrying value. The most common method is straight-line amortisation, spreading the cost evenly over the estimated useful life.

For example, if your company acquires a patent for £30,000 with a 10-year useful life, the annual amortisation charge is £3,000. After 5 years, the carrying value on the balance sheet would be £15,000 (£30,000 cost minus £15,000 accumulated amortisation).

At each year end, you should assess whether there are any indicators of impairment -- meaning the asset may be worth less than its carrying value. If an intangible asset becomes impaired (for example, a patent becomes less valuable because competing technology emerges), you write down the carrying value immediately, recording an impairment loss on the P&L. This is in addition to the regular amortisation charge.