Are Patents a Current Asset? Accounting for Intangibles
Understand the accounting principles guiding patent classification, clarifying their typical long-term intangible asset status.
Patents are a form of intellectual property that grants exclusive rights to an inventor for a specific period, typically for a new and useful invention. These rights allow the patent holder to prevent others from making, using, selling, or importing the invention without permission. Understanding how patents are classified and accounted for in financial reporting provides insight into a company’s financial health.
Understanding Asset Classification
Assets are broadly categorized based on their expected period of benefit. Current assets are those expected to be converted into cash, sold, or consumed within one year or one operating cycle, whichever is longer. Examples include cash, accounts receivable, and inventory. Non-current assets are those assets that are not expected to be converted into cash or consumed within one year.
Non-current assets include intangible assets. These assets lack physical substance but possess significant long-term value. Patents, along with trademarks, copyrights, and goodwill, are intangible assets, representing legal rights or economic advantages rather than physical property.
Patents as Intangible Non-Current Assets
Patents are classified as non-current, intangible assets due to their typical useful life. Utility patents, for example, generally provide protection for 20 years from their filing date, a period longer than one year. This extended period means economic benefits are realized over many years, solidifying their non-current classification.
The accounting treatment for patents depends on how they are obtained. When a patent is acquired, costs like the purchase price and legal fees are capitalized. The capitalized cost is systematically expensed over its useful life through amortization, similar to how tangible assets are depreciated. The amortization period is typically the shorter of the patent’s legal life or its estimated useful life.
Accounting for internally developed patents differs. Generally, costs associated with research and development (R&D) activities are expensed as incurred. R&D outcomes are uncertain, and accounting standards require expensing such costs due to the lack of assured future economic benefits. However, certain direct costs to obtain an internally developed patent, such as legal and application fees, can be capitalized once the patent is granted.
Rare Scenarios for Patent Classification
While patents are non-current assets, limited circumstances allow reclassification as current assets. This occurs only if a company intends to sell the patent, and the sale is highly probable within one year from the balance sheet date. This exception requires strict adherence to specific accounting criteria.
For reclassification, specific criteria must be met:
Management must commit to a plan to sell the patent.
The patent must be available for immediate sale in its present condition.
An active program to locate a buyer must be initiated.
The sale must be probable within one year.
The patent must be actively marketed at a reasonable price.
In these rare cases, the patent’s classification shifts to reflect the company’s intent for short-term liquidation.