Amortization

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Amortization발음듣기

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In the depreciation video, we saw that if a company had to buy some equipment for its factory, let's say at the beginning of 2007, just based on the cash that went out of the door, there might have been this temptation to say, OK, in 2007, we had an equipment expense. EQ expense.발음듣기

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And they could have just wrote, let's say that equipment cost $50,000.발음듣기

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So they would have just put a $50,000 expense right in 2007.발음듣기

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I write it as a negative number just because I like to remember it's an expense, although normally people just write it as a positive expense, but I always like to put a negative for an expense to know that it's going to subtract from your revenue.발음듣기

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So they would put that cash expense there in 2007.발음듣기

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And then in future years, maybe 2008, 2009, 2010, they would have no expense until maybe they had to replace that machine or buy a new one.발음듣기

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And we saw that that is one way to account for things, but it really doesn't reflect the reality of the business.발음듣기

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The fact that this machine right here that cost $50,000 is used for - in this example, in the depreciation video, it was usable for two years.발음듣기

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Let's say in this example, it's usable for four years.발음듣기

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So what they do is, instead of just expensing the cost of the machine, when the machine is bought on the balance sheet at the beginning of 2007, they say, we now have an asset called a machine.발음듣기

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I'll just call it M for machine.발음듣기

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That's $50,000 at this point right here, right when we bought the machine.발음듣기

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Remember, balance sheets are snapshots in time.발음듣기

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And then instead of having an equipment expense, instead of having that expense, they'll have an equipment depreciation expense.발음듣기

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And the difference here is instead of saying that the entire expense was that machine in just the first period, they're saying no, we're using some of the machine in that period.발음듣기

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And let's say we do a straight-line depreciation, which means we essentially depreciate the asset evenly over its lifespan.발음듣기

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So in this case, we're assuming it's a four-year lifespan.발음듣기

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So let me draw that out.발음듣기

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So the asset should linearly go to zero over these four years.발음듣기

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So essentially, in the first year, our expense would be what?발음듣기

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It's $12,000.발음듣기

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If you divide $50,000 by 4, it's $12,500.발음듣기

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It would be minus $12,500 in each year, depreciation expense, and we would account for it on the balance sheet.발음듣기

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Because remember, income statements are just telling you how do you get from one balance sheet to another.발음듣기

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So expenses reduce the value of your assets.발음듣기

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So, for example, in this one, at the beginning of the period, before the 2007 income statement, the asset was worth $50,000.발음듣기

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We depreciated $12,500 from it, so at this point in time, the balance sheet as of the end of 2007 or the beginning of 2008, we're going to say that our machine is now $12,500 less, so $47,500.발음듣기

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And then at the end of 2008, beginning of 2009, our balance sheet under the assets, the machine, if they gave us that level of granularity, would be $12,500 less than that.발음듣기

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So that's what? $37,500.발음듣기

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So then the machine is $25,000.발음듣기

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And then another $12,500 on the books.발음듣기

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It'll say the machine is worth $12,500.발음듣기

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And then at the end of 2010, it'll say the machine is worth nothing.발음듣기

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And if we did our depreciation schedule right, or if the lifespan of this machine really is four years, then it's time to go buy another machine and start doing this all over again.발음듣기

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This is all a review of the depreciation video.발음듣기

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Amortization is the exact same thing, but it deals with intangible assets.발음듣기

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What's an intangible?발음듣기

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It's something you can't see, touch, feel, smell, eat.발음듣기

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Obviously , a machine you can't do all of those things to it, but you can at least touch it and possibly smell and taste it.발음듣기

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So an intangible asset, we can't do any of that stuff to, but it's the exact same idea.발음듣기

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For example, let's say we are some type of widget company.발음듣기

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And let me write down the years: 2007, 2008, 2009 and 2010.발음듣기

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And let's say that if we just did it from a cash point of view, let's say we had to buy a patent in order to make our widgets.발음듣기

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So we could have said, oh, we have to buy a patent expense.발음듣기

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We had to buy a patent from some brilliant inventor someplace.발음듣기

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We could just say, oh, you know what?발음듣기

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The patent cost $4,000.발음듣기

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So we could just put that there even though the useful life of the patent might be four years.발음듣기

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And so it doesn't reflect the fact that we still are using that patent in these years, and we just take the hit here.발음듣기

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So this income will look unusually low, while these will look unusually high.발음듣기

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It's not reflective of the fact that you're using this patent that has four years left on it.발음듣기

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So instead of doing that, what you do is, at the beginning of the period you say, we have acquired a patent, an asset, that is worth $4,000, And then every year over the life of the patent, we'd amortize a fourth of it since it has a four-year life.발음듣기

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So it would be patent amortization.발음듣기

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And there's all sorts of intangible assets that you might amortize.발음듣기

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And amortizing really just means spreading out the cost of this asset, just like depreciation was spreading out the cost of a physical asset.발음듣기

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So patent amortization would be $1,000 in this year, $1,000 in this year, $1,000 in this year, and $1,000 in this year.발음듣기

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And then our snapshot, or our balance sheet at the end of 2007, will have on its assets a patent that's now worth $3,000.발음듣기

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And at the end of 2008, it'll have a patent that's now worth $2,000.발음듣기

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The end of 2009 - I think you get the point - you'll have a patent worth $1,000.발음듣기

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And at the end of 2010, probably because the patent is now expired and anyone can go out and produce whatever that invention that was patented without having the patent, we then say that the patent is worthless.발음듣기

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And a very relevant thing is if you were a drug company and you were buying the patent to some pharmaceutical that had four years left so that you could have exclusive rights to develop that drug.발음듣기

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and at this point, all of a sudden, now anyone can develop the drug, so that patent is worthless.발음듣기

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So the balance sheet is really trying to capture what your asset is worth at that point in time.발음듣기

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At this point in time, your patent is arguably only worth $1,000, because you paid $4,000 for four years, and now you only have a year left.발음듣기

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But that's all amortization is. Nothing fancy.발음듣기

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Really, in my mind, it's very similar to depreciation.발음듣기

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Depreciation is tangible.발음듣기

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Amortization is intangible.발음듣기

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It could be patents, it could be licenses.발음듣기

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It could be fees associated with the financing.발음듣기

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Let's say you have some debt that you took from a company, and the debt is going to last for 10 years, and you had to pay a one-time lump-sum to the bank.발음듣기

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Well, that one-time lump-sum fee should probably be spread over the life of the debt, so you would amortize that expense over its life.발음듣기

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Anyway, see you in the next video.발음듣기

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