A patent is a type of intangible (not physical) asset that gives a business the legal right to make and sell a product exclusively for a fixed period of time. When your small business buys a patent from a third party, generally accepted accounting principles, or GAAP, require you to amortize the cost in your accounting records.

To amortize means to spread the cost as an expense on your income statement over the life of the patent. Amortization helps you properly record expenses in the periods in which you receive an economic benefit from a patent, which helps you avoid overstating or understating your profits.

1. Debit the Patent's Total Cost in a Journal Entry

Debit the patent’s total cost to the patent account in a journal entry in your accounting records when you acquire the patent.

A debit increases the patent account, which is an asset on the balance sheet.

The cost includes the purchase price plus any legal or other fees necessary to use the patent.

GAAP allows only patents acquired from third parties to be recorded on your balance sheet and amortized.

For example, assume a patent’s total cost is $52,000.

Debit $52,000 to the patent account.

2. Credit the Cash Account in the Same Journal Entry

Credit the same amount to the cash account in the same journal entry.

A credit decreases cash, which is also an asset on the balance sheet.

In this example, credit $52,000 to cash.

3. Subtract the Patent's Expected Residual Value

Subtract the residual value you expect the patent to have at the end of its useful life from its cost. In this example, assume you estimate that the patent will be worth $2,000 at the end of its useful life.

Subtract $2,000 from $52,000 to get $50,000.

4. Determine the Patent's Amortization Expense

Divide your result by the patent’s useful life to determine its amortization expense each period.

The useful life is the number of years or other periods that you expect the patent will generate an economic benefit to your small business.

A patent’s life can last up to its legal expiration, but can sometimes be shorter.

In this example, assume the patent’s useful life is 10 years.

Divide $50,000 by 10 to get a $5,000 annual amortization expense.

5. Debit the Patent's Amortization Expense

Debit the amortization expense to the amortization expense account in a new journal entry at the end of each accounting period of the patent’s useful life.

A debit increases the amortization expense account on your income statement, which reduces your profit.

In this example, debit $5,000 to the amortization expense account at the end of each of the next 10 years.

6. Credit the Patent Account

Credit the same amount to the patent account in the same journal entry each period.

A credit reduces the patent account.

As you amortize the patent with this journal entry each accounting period, the patent’s initial cost on the balance sheet gradually decreases and reaches its residual value at the end of its life.

Concluding the example, credit $5,000 to the patent account at the end of each of the next 10 years.