By TJ Porter, WCI ContributorIf you have your own practice, you likely own a variety of equipment that you use on a daily basis. When it comes time to file your taxes, it’s important to properly account for the value of those assets, depreciating them over time.
However, some assets aren’t tangible things that wear down and lose value over time. Intangible assets like branding, customer lists, or lease agreements also have value but don’t depreciate like physical assets. Instead, they amortize.
What Is Amortization in Accounting?
Amortization is the process of writing down the value of intangible assets over time. This moves the value of intangible assets from your balance sheet to the income statement.
There are many different intangible assets that a physician’s practice can have. Things like a list of patients, branding, software licenses, and domain names for your website all count as intangible assets.
Though they aren’t physical things, these assets have a financial value. If you have an established practice, you likely have a long list of patients you see regularly and who pay you for your services. If you moved to a new place and had to start over, it would take time to rebuild your income by finding new patients to work with. Your patient list has financial value, because it gives you regular work and income.
Despite the fact that they don’t wear out over time the same way a piece of medical equipment does, some intangible assets have an expected useful life or will fall in value. Amortization allows you to account for that decrease in value or the end of their useful life, booking the fall in value as an expense on your company’s income statement.
It’s important to note that amortization can also refer to the process of paying off debt over time. At the start of a loan, your payments cover a lot of interest and a small amount of principal. As you pay down the principal, less interest accrues each month, meaning future payments go more toward the principal and less toward interest.
A loan amortization schedule shows the change in the amount of each payment that goes toward principal and interest over time.
More information here:
How to Evaluate a Medical Practice Buy-In
How to Calculate Amortization Expense
Before you can calculate amortization expense, you need to determine two things: the value of the intangible asset you want to amortize and its useful life.
For example, imagine you purchase a license to use a piece of medical software. The license lasts for 10 years and costs $20,000. That puts the value of the license at $20,000 and its useful life at 10 years. Typically, you amortize on a straight-line basis, meaning you amortize the same amount each year over the full life of the asset. Divide the value of the asset ($20,000) by the lifespan of the asset (10 years), and you’ll get the amount of the annual amortization expense.
$20,000/10 = $2,000, meaning your annual amortization expense for the software license is $2,000.
Some intangible assets don’t have clear values. For example, it can be hard to determine the value of your patient list. You can work with an accounting expert to figure out a fair value for your intangible assets and use that value for amortization.
Why Amortization Expenses Are Important for You
Amortization expenses are important for physicians with their own practices because they play a big role in your business’s accounting processes. Properly using amortization expenses can help you reduce the amount of taxes that you pay.
Imagine that your practice produces $750,000 in revenue and has $200,000 in expenses. You’d have a net profit of $550,000 and would have to pay various taxes on that profit. If you have intangible assets and book amortization expenses of $50,000, you can reduce your practice’s net profit to $500,000. That means you reduce the amount of revenue that you owe taxes on because your company’s net profit is lower.
More information here:
Buying into (or Selling Part of) a Business
The Bottom Line
Amortization allows businesses to write down the value of certain intangible assets over time. That lets you reduce the amount of profit that your company needs to report, reducing the amount it owes in taxes.
Physicians’ practices can have a wide range of different intangible assets, so understanding their values and how to properly amortize them is important to managing your practices’ accounting records.
The White Coat Investor is filled with posts like this, whether it’s increasing your financial literacy, showing you the best strategies on your path to financial success, or discussing the topic of mental wellness. To discover just how much The White Coat Investor can help you in your financial journey, start here to read some of our most popular posts and to see everything else WCI has to offer. And make sure to sign up for our newsletters to keep up with our newest content.
