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Intangible assets are non-physical assets with no tangible form that hold value for a company. Like other assets, these can be economic inflows to a company. One item that falls under this category is patents.
What is a Patent?
A patent is a legal right granted by a government to inventors or their assignees, offering exclusive control and protection over their innovative creations. This protection, which typically lasts for about 20 years, allows the patent holder to have a monopoly on the use, manufacturing, sale, and licensing of their invention, preventing others from exploiting it without permission.
Patents are vital intellectual property, incentivizing inventors to disclose their novel and non-obvious ideas to the public while ensuring they reap financial benefits and recover development costs. Inventors must submit a patent application detailing their invention to the relevant government patent office to acquire a patent.
What is the accounting for a Patent?
Accounting for a patent involves recognizing and managing the costs associated with acquiring and maintaining the patent, determining its value, and accounting for it over time. Initially, when a company incurs costs to obtain a patent, these expenses are capitalized as an intangible asset on the balance sheet. Subsequently, the company amortizes the patent’s cost over its estimated useful life, typically not exceeding 20 years.
Ongoing costs for maintaining the patent, such as legal and maintenance fees, are expensed as incurred rather than capitalized. If there are indications that the patent’s value has decreased, impairment testing is necessary, and the patent may need to be written down to its recoverable amount. Transparent disclosure of patent-related information is a vital component of financial reporting. However, GAAP and IFRS accounting may differ for patents.
What is the journal entry for Patents?
The first journal entry for a patent occurs when a company initially acquires it. The recognition falls under the accounting standard for intangible assets. This standard is similar under both IFRS and GAAP, with a few minor differences. When a company initially recognizes a patent, it must use the following journal entry.
| Dr | Patent |
| Cr | Bank or cash or accounts payable |
Under the accounting standard for intangible assets, companies may also amortize the patent cost. This process is similar to depreciation. Essentially, the company splits the patent’s costs over its life. The journal entry to record this transaction is as follows.
| Dr | Amortization |
| Cr | Accumulated amortization |
On top of that, patents may also come with ongoing costs, as mentioned above. These may include legal and maintenance fees. Companies can charge these expenses to the income statement using the following journal entry.
| Dr | Patent expenses |
| Cr | Bank or cash or accounts payable |
Example
Red Co. incurs costs to develop a patent, incurring $10,000 in a patent application and legal fees. The company pays for the expense using its bank account. Under the accounting standard for intangible assets, Red Co. can capitalize these costs. Therefore, the company uses the following journal entry to record the patent.
| Dr | Patent | $10,000 |
| Cr | Bank | $10,000 |
Red Co. estimates the patent to have a life of 10 years. Based on that, the annual amortization charge for it is $1,000 ($10,000/10 years). The company uses the following journal entry to record it.
| Dr | Amortization | $1,000 |
| Cr | Accumulated amortization | $1,000 |
Conclusion
A patent is an intangible asset that represents the value of the legal right to control an idea or innovation. Companies must record these as an asset on their balance sheet. However, the accounting for a patent may differ depending on whether a company uses IFRS or GAAP. The process also involves various stages, as mentioned above.
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