A patent is a property right that gives the patent holder exclusive rights to use an invention, design, process or other intellectual property. The United States Patent and Trademark Office reviews patent applications and grants patents, which give individuals or companies effective monopoly rights for a limited number of years. Patents go in the intangible assets subsection of the classified balance sheet.
Intangible assets are part of the long-term assets section on the balance sheet. Intangibles include patents, copyrights, trademarks, franchise licenses, goodwill and other nonphysical items that do not have a readily available market value. However, companies use intangible assets to generate long-term economic benefits. For example, a semiconductor company may license its patents to manufacturers, thus generating a steady cash flow stream for the life of the patents. Intangible assets are long-term assets because companies use them for long periods and they are not easily convertible to cash.
The accounting process for patents is similar to other fixed assets. Companies allocate or amortize the costs over the life of the patent. Patent costs include registration, documentation and legal fees for defending the patents against unauthorized use. Research and development costs are not part of patent costs because they are part of operating expenses. Companies must use the straight-line method to amortize patents and other intangible assets, in which the amortization expense is the same each year. For example, if a company acquires a 15-year patent for $1 million, the annual straight-line amortization expense is about $67,000.
Companies debit amortization expense and credit accumulated amortization to record the amortization of patent costs. Accumulated patent amortization is a contra account that reduces the value of patents in the intangible assets section on the balance sheet. Continuing with the example, the book value of the patent after one year is $933,000 ($1 million - $67,000). Companies may record the amortization directly to the patent account instead of using a separate contra account, in which case it would debit the amortization expense account and credit the patent account.
Patent valuation may part of a due diligence process for a business sale or merger. In a November 2004 article, certified public accountant J. Timothy Cromley suggests a multi-step process for valuing patents. These steps include verifying if the patent is still in force, reading the patent application documentation and estimating the present value of future cash flow streams from the patent.
Debits increase asset accounts, such as patents, and expense accounts, such as amortization expense. Debits decrease revenue, liability and shareholders' equity accounts. Credits decrease asset and expense accounts, and increase revenue, liability and shareholders' equity accounts. Credits also increase contra asset accounts, such as accumulated depreciation and accumulated amortization, which reduce the book value of tangible and intangible assets, respectively.