Are Patents Intangible Assets? Accounting Treatment
Demystify the financial recording of innovation. Understand how intellectual property is recognized and managed on balance sheets.
A business relies on various resources to operate and generate revenue. These resources can take many forms, from physical structures and equipment to financial instruments. While tangible assets are easily recognized due to their physical presence, businesses also possess valuable resources that lack a physical form. Understanding these different types of assets is important for comprehending a company’s true value and operational capacity.
Understanding Intangible Assets
Intangible assets are resources that lack physical substance but hold economic value for a business. They are distinct from tangible assets like buildings or machinery, yet they significantly influence a company’s operations and long-term viability. For an asset to be classified as intangible, it must meet specific criteria: it should be identifiable, meaning it can be separated or arise from legal or contractual rights, and it must be expected to generate future economic benefits for the entity.
These assets are recorded on a company’s balance sheet as long-term assets because their value contributes to the business over an extended period, more than one year. Common examples of identifiable intangible assets include trademarks, which protect brand names and logos; copyrights, which protect original works of authorship; and patents, which grant exclusive rights to an invention. Goodwill, representing the value of a company’s reputation or customer relationships, is another common intangible asset.
Patents as an Intangible Asset
Patents directly align with the definition of an intangible asset, as they represent a legal right granted for an invention without possessing physical form. A patent provides the inventor with exclusive rights to prevent others from making, using, or selling the patented invention for a limited period. This legal protection grants the patent holder a competitive advantage and the ability to generate future economic benefits, such as through sales, licensing, or preventing competitors from utilizing the protected technology.
In the United States, there are three primary types of patents, each protecting different aspects of an invention. Utility patents are the most common, protecting new and useful processes, machines, manufactures, or compositions of matter, including functional aspects of an invention. Design patents, in contrast, safeguard the unique visual and ornamental characteristics of a manufactured item, focusing on how something looks rather than how it functions. Plant patents protect new varieties of plants that are asexually reproduced.
Accounting for Patents
When a company acquires or develops a patent, it is recognized on the balance sheet as an intangible asset at its cost. This initial cost includes direct expenditures such as legal fees for drafting and submitting the patent application, registration fees, and other costs directly attributable to securing the patent rights. However, research and development (R&D) costs incurred to create the underlying invention are expensed as incurred and are not capitalized as part of the patent’s cost, as they are considered risky without guaranteed future benefits.
Once recognized, patents with a finite useful life are subject to amortization, a process similar to depreciation for tangible assets. Amortization systematically allocates the patent’s cost over its estimated useful life, which is often its legal life or a shorter economic life if the patent is expected to be useful for a lesser period. For utility patents in the U.S., the legal life is 20 years from the date the application was filed, as per 35 U.S.C. § 154. The amortization expense is recorded on the income statement, reducing the patent’s carrying amount on the balance sheet over time.
Companies must also periodically assess patents for impairment. Impairment occurs when the patent’s carrying amount on the balance sheet exceeds its recoverable amount, indicating a significant decline in its economic value. This decline can result from technological obsolescence, legal challenges, or changes in market conditions. If impairment is identified, the patent’s value is written down to its new lower recoverable amount, and an impairment loss is recognized on the income statement, reflecting the unexpected reduction in the asset’s value.