Amortisation

Amortisation has two slightly different meanings, depending on whether you’re in America or Britain. In the States it refers to the process of spreading the cost of any asset – intangible or tangible – over its useful economic life as estimated by the directors. In Britain, amortisation specifically refers to this process in relation to intangible fixed assets (such as goodwill).

Tangible fixed assets, such as buildings, are depreciated – a similar process with a different name. Either way, the principle is that a firm’s long-term assets will be used to generate income over many accounting periods and not just one.

So it would be misleading to dump the cost of the asset in the profit and loss account in the year of acquisition. Instead, it is better to spread it and charge it bit by bit as the asset is used up. This involves judgement, which is why some analysts prefer to replace the earnings figure with earnings before interest, tax, depreciation and amortisation (EBITDA).

• See Tim Bennett’s video tutorial: Beginner’s guide to investing: the EV/EBITDA ratio.

Merryn

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