Definition
Amortization of Deferred Charges is an accounting procedure applied to intangible assets, similar to how depreciation is applied to tangible assets. According to Generally Accepted Accounting Principles (GAAP), the cost associated with an intangible asset should be amortized—written off over the asset’s useful life. This amortization often applies to costs such as fees incurred to arrange loans or leases, which are then written off over the term of the loan or lease.
Key Components
- Amortization: Spreading the cost of an intangible asset over its useful life.
- Deferred Charges: Costs that are incurred in securing financial benefits that will be received over time.
- Intangible Assets: Non-physical assets such as patents, trademarks, or deferred financing fees.
- GAAP Compliance: Ensures accurate financial reporting in accordance with accepted accounting standards.
Examples
Example 1:
A company incurs a 2% fee amounting to $20,000 to arrange financing for a small office building with a 20-year term. Under amortization, 1/20 of the fee, which is $1,000, is written off each year on the company’s financial statement and tax return, resulting in a $1,000 annual tax deduction.
Example 2:
A firm acquires a software license for $100,000 to be used over ten years. Under the amortization of deferred charges, the firm expenses $10,000 annually. This amortized cost reflects the yearly usage of the software’s value on financial statements.
Frequently Asked Questions
What are deferred charges in real estate?
Deferred charges in real estate are costs incurred to secure financing or leases, which benefit multiple accounting periods and are therefore amortized over those periods.
How is amortization different from depreciation?
Amortization relates to intangible assets (like loan fees or patents) and spreads the cost over its useful life. Depreciation applies to tangible assets such as buildings or equipment.
Are all deferred charges amortized over the same period?
No, the amortization period for deferred charges depends on the term of the related financing or lease, or the useful life of the intangible asset.
Is amortization mandatory under GAAP?
Yes, GAAP requires that the costs associated with intangible assets be amortized over their useful lives.
Related Terms with Definitions
Depreciation
The allocation of the cost of a tangible asset over its useful life.
Useful Life
The estimated time period that an asset is expected to be productive or useful to its owner.
Intangible Asset
A non-physical asset that has value, such as patents, copyrights, or deferred financing fees.
Net Income
The amount of profit remaining after all expenses, including amortization, have been deducted from total revenues.
Online Resources
- Investopedia - Amortization
- Financial Accounting Standards Board (FASB)
- U.S. Securities and Exchange Commission (SEC) - Financial Reporting Manual
References
- Financial Accounting Standards Board (FASB) guidelines on Intangible Assets
- Generally Accepted Accounting Principles (GAAP) documentation
- U.S. Internal Revenue Service (IRS) guidelines on amortization and depreciation
Suggested Books for Further Studies
- “Accounting for Non-Accountants” by Wayne A. Label
- “Financial Reporting and Analysis” by Charles H. Gibson
- “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
- “Intangible Assets: Values, Measures, and Risks” by Jeffrey A. Cohen
