What is Straight Line Amortization?

Straight-line amortization is one of the methods used for the amortization of the cost of the intangible assets or allocating the interest expenses which are associated with the issue of the bond by the company equally in each of the accounting period of the companyAccounting Period Of The CompanyAccounting Period refers to the period in which all financial transactions are recorded and financial statements are prepared. This might be quarterly, semi-annually, or annually, depending on the period for which you want to create the financial statements to be presented to investors so that they can track and compare the company’s overall performance.read more until the end of the life of the intangible asset or until maturity of bond respectively in the income statement of the company.

Types of Straight-Line Amortization

The following are the main situation in case of which the method of Straight Line Amortization is used:

#1 – Allocation of the Interest on the Bonds

Under this situation, the company allocates the interest on the bond issued by it equally over the asset’s life. This interest arises when the company issues the bonds at a discount, but the interest is payable on the face value. So, the company must amortize the bondAmortize The BondWhen a company issues bonds to investors with a coupon rate that is higher than the market rate of interest, the investors may bid higher than the face value of the bond. The excess premium received is amortized by the company over the bond term, and the concept is known as Amortization of Bond Premium .read more discount given, i.e., the difference between the face value and the value received over the remaining period of maturity of the bond.

#2 – Charging off Cost of Intangible Asset

Under this method, the cost of intangible assetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can’t touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. read more such as patents, goodwill or intellectual property, etc., is charged over the useful life of that intangible asset in equal yearly amounts.

#3 – Monthly Installment of Loan

When the loan is to be repaid in equal installment, it is also referred to as Straight-line amortization.

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Straight Line Amortization Formula

The formula for the calculation of the Straight Line Amortization is as follows:

Where,

  • Total Interest amount = difference between the face value and the value received over the remaining period of maturity of the bondThe number of periods in the life of Bond= Remaining period of the bond until maturity.

  • Cost of the intangible assets= amount paid for the intangible asset minus the salvage valueSalvage ValueSalvage value or scrap value is the estimated value of an asset after its useful life is over. For example, if a company’s machinery has a 5-year life and is only valued $5000 at the end of that time, the salvage value is $5000.read more of that intangible asset.The useful life of the intangible assets = number of years of Useful remaining life remaining of that intangible asset;

Examples

Example #1 – Allocation of the Interest on the Bonds

For Example, Company A ltd. issued the 1000 bonds in the market having a face value of $1,000 each at $970 each. The period for which the bond is issued in the market is six years. Calculate the charge of interest every year in the company’s income statement using the Straight Line method.

Solution

In the present case, the face value of each of the bonds issued is $1,000, and the issue price is $ 970. So the discount issued per bond comes to $30 ($1,000- $970). So the total discount given for all the bonds comes to $30,000 (discount per bond * number of bonds issued = $30* 1,000).

A company needs to amortize this discount because a discount arises when the company issues the bonds at a value less than its face value. Still, the interest is payableInterest Is PayableInterest Payable is the amount of expense that has been incurred but not yet paid. It is a liability that appears on the company’s balance sheet.read more on the face value and not on the discounted issue price. Now, by using a method of the straight line, bond discount will be written offWritten OffWrite off is the reduction in the value of the assets that were present in the books of accounts of the company on a particular period of time and are recorded as the accounting expense against the payment not received or the losses on the assets.read more by the company in the equal amounts over a bond’s life as follows:

  • Total Interest Amount = $ 30,000Number of a Period in the life of Bond = 6 years

Calculation of Straight-Line Amortization

  • = $ 30,000 / 6= $5,000

Thus every year, $5,000 will be charged to the company’s income statement for the next six years.

Example #2 – Charging off the Cost of Intangible Asset

For Example, Company A ltd buys goodwillGoodwillIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company’s net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company’s net identifiable assets from the total purchase price.read more for $70,000, having an estimated useful life of seven years with no salvage value at the end. Calculate the yearly charge using the straight-line amortization method.

  • Cost of the intangible assets=$ 70,000.The useful life of the intangible assets= 7 years

  • = $ 70,000 / 7= $10,000

Thus every year, $10,000 will be charged in the income statement of the company for the next seven years.

Advantages

The different advantages are as follows:

  • It is a simple and less time-consuming method as every year; an equal amount is to be charged to the income statementIncome StatementThe income statement is one of the company’s financial reports that summarizes all of the company’s revenues and expenses over time in order to determine the company’s profit or loss and measure its business activity over time based on user requirements.read more of the company.The straight-line amortization method is one of the very useful accounting principlesAccounting PrinciplesAccounting principles are the set guidelines and rules issued by accounting standards like GAAP and IFRS for the companies to follow while recording and presenting the financial information in the books of accounts.read more because using this, the expenses or interest is calculated quickly.

Disadvantages

The different disadvantages are as follows:

  • Generally, all the intangible assets do not perform each year uniformly, so the Straight-line amortization method does not account for these variations.In cases where functional life span cannot be estimated properly, this method will not be useful.

Important Points

The different important points are as follows:

  • Estimating the functional lifespan or the maturity of intangible assets or bonds and loans is required.It systematically leads to the same amount movement in every accounting period from the balance sheet account of the companyBalance Sheet Account Of The CompanyA balance sheet is one of the financial statements of a company that presents the shareholders’ equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner’s capital equals the total assets of the company.read more to the income statement account.

Conclusion

Straight-line amortization equally charges the cost of assets or interest in each of the company’s accounting periods until the end of the life of the intangible asset or until the maturity of the bond, respectively, in the company’s income statement.

It is a simple and less time-consuming method as every year; an equal amount is to be charged to the company’s income statement. However, in cases where functional life span cannot be estimated properly, this method will not be useful.

This article is a guide to Straight-Line Amortization. Here we discuss the types, formula for calculating straight-line amortization, and examples, advantages, and disadvantages. You can learn more about accounting from the following articles-

  • Goodwill AmortizationAmortization Schedule for a MortgageCreate a Loan Amortization ScheduleAmortization of Intangible Assets