The Word That Means Two Different Things
Amortisation is one of those accounting words that trips people up because it does two jobs. Ask an accountant and they will tell you it is how you spread the cost of an intangible asset across its useful life. Ask a mortgage adviser and they will tell you it is how a loan balance falls to zero as you make repayments. Both are right. They are just describing different things with the same word.
This guide deals mainly with the accounting sense, because that is the one that lands in your company accounts and changes how your profit looks. We will cover the loan sense too, because plenty of people searching for "amortisation meaning" actually have a repayment schedule in front of them and want to know what they are looking at.
Defining Amortisation
Amortisation is the systematic write-off of the cost of an intangible asset over the period it is expected to benefit the business. It works exactly like depreciation, but depreciation applies to physical things you can touch and amortisation applies to things you cannot.
An intangible asset is something of value that has no physical form. The common examples in UK accounts are:
- Purchased goodwill, the premium you pay when buying another business above the value of its identifiable assets
- Software licences and developed software
- Patents, trademarks, and registered designs
- Customer lists and contracts acquired with a business
- Development costs that meet the recognition criteria
If a business pays £50,000 for a ten-year patent, that £50,000 is not an expense in year one. The patent will earn its keep over a decade, so the cost is spread across those ten years at £5,000 a year. That annual £5,000 charge is amortisation.
The logic is the matching principle, the same idea that drives depreciation. Costs should appear in the same period as the revenue they help create. A patent that protects a product for ten years should cost the accounts a slice of its price in each of those ten years, not the whole lot up front.
How Amortisation Is Calculated
Most amortisation in UK small company accounts uses the straight-line method. You take the cost, subtract any residual value (usually nil for intangibles), and divide by the useful life.
Annual amortisation = (Cost − Residual Value) ÷ Useful Life
A worked example. A design agency buys a software licence for £24,000 with a useful life of four years and no residual value:
£24,000 ÷ 4 = £6,000 per year
That £6,000 hits the profit and loss account every year for four years. The asset's carrying value on the balance sheet falls by £6,000 each year until it reaches zero at the end of year four.
The double entry is the mirror of depreciation:
- Debit Amortisation expense (P&L)
- Credit Accumulated amortisation (balance sheet, against the intangible asset)
Residual value matters less for intangibles than for physical assets. A patent at the end of its protection period is usually worth nothing, so the full cost is written off. There is no second-hand market for most intangibles the way there is for a van, so you rarely see a meaningful residual figure.
Amortisation vs Depreciation
This is the comparison people search for most, and the honest answer is that they are the same mechanism applied to different asset types. The differences are in the detail rather than the principle.
| Depreciation | Amortisation | |
|---|---|---|
| Applies to | Tangible fixed assets (vans, machinery, buildings) | Intangible assets (goodwill, software, patents) |
| Common methods | Straight-line and reducing balance | Almost always straight-line |
| Residual value | Often meaningful (a van has resale value) | Usually nil |
| Balance sheet line | Property, plant and equipment | Intangible assets |
| UK standard | FRS 102 Section 17 | FRS 102 Section 18 and 19 |
The shared idea is that a long-life asset is paid for once but earns its value over years, so the cost is spread to match. The split into two words is really just bookkeeping tidiness: it keeps physical and non-physical assets in separate notes in the accounts. For a fuller treatment of the physical side, our depreciation guide covers straight-line and reducing balance in detail, including why land is the famous exception that never depreciates.
There is a third cousin worth a mention. Depletion is the same concept applied to natural resources like a quarry or an oil field, where the asset is physically used up. You will rarely meet it in a typical UK small business.
The FRS 102 Rules That Catch People Out
Under UK GAAP, intangible assets and goodwill must have their useful life estimated, and that estimate drives the amortisation period. The rule that surprises owners is what happens when you cannot estimate the life reliably.
FRS 102 paragraph 18.20 and paragraph 19.23 say that where a reliable estimate of the useful life of an intangible asset or goodwill cannot be made, the life must not exceed ten years. In practice this means a lot of purchased goodwill ends up amortised over ten years by default, because pinning down exactly how long the benefit of an acquisition will last is genuinely hard.
This is a real divergence from international standards. Under IFRS (IAS 38), intangibles with an indefinite useful life are not amortised at all. They are tested for impairment each year instead. Goodwill under IFRS is never amortised, only impairment tested. So the same acquisition can carry a steady annual amortisation charge in a company using FRS 102 and no amortisation charge at all in a group reporting under IFRS. We unpack this split in our goodwill in accounting guide, because it changes reported profit and trips up anyone comparing two sets of accounts side by side.
The other catch is that amortisation, like depreciation, is not deductible for corporation tax in most cases. The accounting charge is added back in the tax computation. There is a separate regime, the corporate intangibles regime, that gives tax relief on qualifying intangible assets acquired since April 2002, usually following the accounting amortisation. The rules are narrow and have changed over the years, so the tax treatment of any given intangible needs checking rather than assuming.
Why Amortisation Matters for Profit and Valuation
Amortisation is a non-cash charge. No money leaves the business in the year you book it; the cash went out when you bought the asset. But it still reduces your reported profit, which has two practical consequences.
First, it can make a profitable, cash-generating business look weaker on paper than it is. A company that bought a lot of goodwill in an acquisition might carry a heavy amortisation charge for ten years, dragging down net profit even while cash piles up.
Second, this is exactly why investors and buyers look at EBITDA, which stands for earnings before interest, tax, depreciation and amortisation. Stripping out amortisation (and depreciation) gets closer to the underlying cash performance of the business and makes companies with different asset histories more comparable. Our EBITDA guide walks through why the "DA" in the acronym is there and when adding it back is fair versus misleading.
If you are valuing or selling a business, understanding which charges are amortisation matters a great deal, because the buyer will almost certainly add them back. Our note on how to value a business goes further on this.
The Other Amortisation: Loan Repayments
Now the second meaning. When you take out a repayment mortgage or a fixed business loan, an amortisation schedule shows how each payment splits between interest and capital over the life of the loan.
In the early years, most of each payment is interest and only a little reduces the balance. As the balance falls, the interest portion shrinks and more of each payment chips away at the capital. By the final payment the balance reaches zero. The loan has been "fully amortised."
This is the sense behind a "loan amortisation calculator" or the schedule your lender hands you. It shares the core idea with the accounting meaning, a value reducing steadily to zero over time, but it is about repaying debt, not writing off an asset. The two never appear together: one lives in your loan paperwork, the other in your company accounts.
If you spot the word "amortisation" and want to know which meaning applies, the quick test is simple. If it sits next to goodwill, software, or intangible assets, it is the accounting sense. If it sits next to interest, principal, and a repayment date, it is the loan sense.
A Practical Opinion on What Businesses Get Wrong
A few patterns we see when we pick up a new client's books:
- Goodwill left unamortised. A business gets bought, goodwill goes on the balance sheet, and nobody ever writes it down. Under FRS 102 it should be amortised, and missing it overstates both assets and profit
- Software treated as a cost, not an asset. A £20,000 bespoke system expensed in one year distorts that year and flatters every year after. If it has a multi-year life, it should usually be capitalised and amortised
- Useful lives picked once and never revisited. FRS 102 expects estimates to be reviewed. A patent that has become worthless before its legal expiry should be written down faster, not left amortising on autopilot
- Confusing the two meanings. Owners sometimes think the amortisation in their accounts relates to their bank loan. It almost never does. The loan repayments are a balance sheet movement, and only the interest is a cost
None of these is dramatic in a single year. Across a few years and a growing business, the effect on the numbers a bank or buyer relies on is bigger than people expect.
How IAK Can Help
Amortisation is rules-light but judgement-heavy. The mechanics are simple arithmetic. The hard parts are deciding what counts as an intangible asset, choosing a defensible useful life, and getting the FRS 102 and tax treatment to line up. Those are exactly the judgement calls we make as part of the year end for accounting clients, and the first things we check when reviewing an acquisition.
If you have bought a business, capitalised some software, or simply want to know whether the intangibles on your balance sheet are being treated correctly, that is a quick conversation worth having.
Take a look at our accounting, bookkeeping and tax planning services, or contact us and tell us what intangibles you hold. We will tell you straight whether anything needs fixing.
Sources
- FRS 102, The Financial Reporting Standard applicable in the UK and Republic of Ireland, Section 18 Intangible Assets other than Goodwill and Section 19 Business Combinations and Goodwill
- IAS 38 Intangible Assets, IFRS Foundation
- HMRC, Corporate Intangibles Research and Development Manual (CIRD)