Accounting for Patents (#365)
/The Classification of a Patent
The main issue to keep in mind with a patent is that it’s an intangible asset. That’s because it doesn’t have any physical substance, and yet it still provides some amount of long-term value to the owner. And so, because it’s an intangible asset, there are specific accounting rules to follow.
Capitalization of Patent Costs
First one. You can capitalize the cost to acquire a patent. That should include the cost of the patent application, which is the filing fee, and the documentation, and any associated legal fees. A reasonable question, though, is whether you should bother to capitalize the cost, or just charge the whole thing to expense as incurred. If you’re preparing the patent application yourself, then the cost may not be that great, and the filing fee is fairly modest, too. In that case, you might want to just charge it off, and not mess with all the subsequent accounting for a fixed asset.
A good way to keep from capitalizing these smaller expenditures is to set your capitalization limit a little bit higher than your expected patent filing expenditures, in order to have an accounting policy that backs up your position.
On the other hand, if you’ve got lawyers involved and the patent application is a big one, with lots of documentation, then the cost is going to be a fair amount higher, and then you might want to capitalize the cost.
There’s another scenario, where you buy the patent from someone else. In this case, you could be paying some serious money for the patent, in which case you’ll almost certainly want to capitalize the cost.
And then, of course, there’s the issue of whether you can capitalize the cost of the research and development that resulted in the patent. That would be a large no. Sorry, but you have to charge that to expense. The reason for this treatment is that R&D is considered to be inherently risky, so you can’t prove that there’ll be any future benefit. Therefore, charge it to expense as incurred.
The Useful Life of a Patent
Assuming that you’ve capitalized something into a patent asset, you’ll have to amortize the expense over the useful life of the asset. How long is that? You shouldn’t amortize it for longer than the lifespan of the protection that the patent is giving you. And in cases where you think the actual patent protection is going to be even shorter, it never hurts to set the useful life to that shorter duration.
Just document your reasoning, so that the auditors can access it for the year-end audit. Auditors are not usually going to fight you over shortening the useful life, since that’s more conservative accounting.
The Amortization Method
Then we have the amortization method for a patent. That would be straight-line amortization. It almost never makes sense to use accelerated amortization, since it’s difficult to prove that the value being provided by the patent is declining at an accelerated rate over time.
Patent Asset Impairment
A possible issue that you might have to deal with is the impairment of the patent asset. If it no longer provides value, or at least a reduced level of value, then you should recognize an impairment charge that reduces or eliminates the carrying amount of the asset. What I’ve found with impairments is that it’s really hard to judge whether there’s been a particular amount of impairment. So instead, it’s an all or nothing proposition. Either there’s been no impairment at all, or the impairment is total, in which case you write off the entire remaining carrying amount of the asset.
Keep in mind that, if you’re capitalizing fairly small amounts of expenditures into a patent asset, then no one’s really going to give a hoot if the asset becomes impaired at a later date. In these cases, the amount of the impairment is so small that it’s not worth writing off the asset.
Patent Asset Derecognition
And finally, at the point when you’re no longer making use of a patented idea, you can derecognize the remaining carrying amount of the asset by crediting the balance in the patent asset account and debiting the related balance in the accumulated amortization account. If you do this before the asset has been completely amortized, then any remaining unamortized balance is recorded as a loss.
That last point brings up an interesting issue, which is that you should theoretically be writing off these assets as soon as you’re no longer making use of the patented idea. Does anyone actually know when a patent is no longer being used? If you wanted to really comply with the accounting standards on this, you could get with some of the management staff each year to go over which patents are no longer being used, and then write off the associated assets. That might result in a slight acceleration of your overall expense recognition, which might be of use if you’re trying to report lower profits.