Choice of Amortization Method and Assumptions

The amortization expense, financial statements, and the ratios derived from them may be significantly impacted by a company’s selected amortization method and the accompanying assumptions and estimates.

The Effect of the Choice of Amortization Method and Assumptions on Amortisation Expense, Financial Statements, and Financial Ratios

Both the choice of the amortization method and the estimate of the useful life of an asset can affect the amount of the amortization expense that is recorded in each period. A shorter estimated useful life will result in a higher amortization expense each year over a shorter period. Even then, the total accumulated amortization expense over the life of an intangible asset is never affected by the estimate of the useful life.

Similarly, the total accumulated amortization expense over the life of an intangible asset is never affected by the choice of the amortization method. The amortization expense per period will, however, depend on the amortization method.

For example, if the straight-line method is used, the amortization expense remains constant for each of the years of the asset’s useful life. If, however, the accelerated method is used, the amortization expense will be higher in the earlier years.

Question 1

Which of the following statements is the most accurate?

1. A longer estimated useful life will result in a higher amortization expense each year.
2. The total accumulated amortization expense over the life of an intangible asset is unaffected by the choice of the amortization method.
3. A higher expected residual value will increase the amount of annual amortization expense relative to a lower expected residual value.

Solution

The correct answer is B.

The total accumulated amortization expense over the life of an intangible asset will not be affected by the choice of the amortization method used.

A is incorrect because a longer estimated useful life will result in a lower, not higher, amortization expense each year.

C is incorrect because a higher expected residual value will decrease, not increase, the amount of annual amortization expense relative to a lower expected residual value.

Question 2

How would the decrease of the estimated useful life of an intangible asset affect a company’s net income?

1. It has no effect.
2. It would increase net income.
3. It would decrease net income.

Solution

The correct answer is C.

Decreasing the useful life would increase the depreciation expense, which in turn would decrease net income.