How Do You Account for a Patent
Patents are considered intangible assets and are accounted for in accordance with the accounting standards applicable to the jurisdiction in which the company operates. In general, the costs associated with obtaining a patent are capitalized, which means they are recorded as an asset on the balance sheet and then amortized over the useful life of the patent.
Here are the general steps involved in accounting for a patent:
- Initial Recognition: The costs associated with obtaining a patent, such as legal fees, filing fees, licensing fees, and other directly attributable costs, are capitalized. These costs are recorded as an intangible asset on the balance sheet under the category of ‘Patents.
- Subsequent Costs: Once a patent is recognized, any additional expenditure is generally expensed as incurred unless it enhances the patent’s functionality or extends its life. In such cases, it may be capitalized as part of the patent’s carrying amount.
- Amortization: The capitalized costs are then amortized over the useful life of the patent, which is typically the legal life of the patent or its economic life if it’s shorter. The amortization expense is recorded on the income statement, typically under ‘Amortization Expense’ or under ‘Depreciation and Amortization’ if the company groups these together. The accumulated amortization reduces the carrying amount of the patent on the balance sheet.
- Impairment: If there’s an indication that the patent may be impaired – meaning its recoverable amount is less than its carrying amount – an impairment test is performed. If an impairment loss is identified, it is recognized on the income statement and the carrying amount of the patent on the balance sheet is reduced accordingly.
- Derecognition : When a patent is sold or when it reaches the end of its useful life, it is derecognized (i.e., removed from the balance sheet). Any gain or loss on disposal is recognized in the income statement.
Remember, the exact accounting treatment for patents can depend on the specific accounting standards being used (like GAAP or IFRS) and the circumstances of the individual company. Therefore, companies should always consult with a qualified accountant or auditor to ensure they are correctly accounting for patents.
Example of How to Account for a Patent
Let’s consider an example of a pharmaceutical company, “PharmaXYZ,” that develops a new drug and obtains a patent for it.
Step 1: Initial Recognition
Let’s assume PharmaXYZ incurs costs of $200,000 for research, out of which $100,000 is spent after the pharmaceutical product’s feasibility is established. They also incur $50,000 in legal and filing fees to obtain a patent.
In this case, the research cost of $100,000 spent before the product’s feasibility is confirmed is expensed as incurred per most accounting standards (like IFRS and US GAAP). The remaining $100,000 of research costs and $50,000 for legal and filing fees – $150,000 in total – are capitalized and recorded as a patent on the balance sheet:
- Patent (on the Balance Sheet): $150,000
Step 2: Amortization
Let’s say the patent’s useful life is 10 years. PharmaXYZ will amortize the capitalized cost over this period. So, the annual amortization expense is $150,000 / 10 = $15,000.
Step 3: Impairment
If at any point, PharmaXYZ believes the patent’s recoverable amount has dropped below its carrying amount on the balance sheet (for instance, due to a competitor developing a similar drug), an impairment loss will have to be recognized. This will reduce the patent’s carrying amount on the balance sheet and will be reported as an expense on the income statement.
Step 4: Derecognition
After 10 years, when the patent’s life ends, the remaining carrying amount will be fully derecognized from the balance sheet. If PharmaXYZ sells the patent before it reaches the end of its useful life, any gain or loss on the disposal will be recognized in the income statement.
Keep in mind, this example is simplified. The real-world accounting for patents may involve more complex scenarios and will depend on the specifics of the company and its operations.