How to Account for Patent Expense & Amortization Costs
A patent provides valuable legal protection for the intellectual property that your business has developed, and it gives your company the right to design, manufacture and sell a unique product. Without a patent, anyone can use the proprietary technology or design you invented to make a product and undercut your chances for success. If your company owns a patent, you must amortize it over the life of that patent. Amortization is the process of spreading the cost of the patent over a specific time period. Patents are recorded as an asset, and each year, you have to record the amortization expense of that asset.
Patents are defined as an intangible asset, which means that they’re not assets you can touch or see such as buildings, cars, equipment, machines and land. Patents are grouped with other types of intangible assets such as trademarks, copyrights, and licenses, and they have what is known as a “useful life,” which is the length of time that a business owner believes that the asset will provide value. Amortization is the process of spreading out that cost of the useful life of an asset, in this case, patents.
To properly account for patent amortization expenses, you must determine how far into the future you think that patent will continue to generate revenue for your business. Remember that there’s a difference between the legal term of the patent and the useful life, during which you believe the patent will make your company money. Therefore, a patent that has 15 years left on its legal term, but that you only expect to generate revenue for 10 years, would have an amortization period of 10 years.
To calculate the annual amortization expense for your patent, you need to divide the total cost to obtain the patent by the length of the amortization period. Let’s say that you paid $50,000 for the patent, and you’ve determined that the amortization period is 10 years, you would divide $50,000 by 10. The result would give you an annual amortization expense of $5,000 for your patent.
When you record patent expenses and amortization costs, you must record the number in both the patent amortization expense account ledger and the patent asset account ledger. For example, if the annual amortization expense were $5,000, you would enter a debit to the amortization expense account of $5,000, and a credit to the patent asset account for $5,000.