Many companies engage in continual research to develop new products. If the company engaged in research stumbles upon a new process or a new product, the company may file for a patent. Patent accounting requires the accountant to understand what expenses can be written off and which must be capitalized as part of the cost of the patent.
A patent represents the right of an individual or company to own an invention and exclude others from creating it. The invention may be a product or a process. The company or individual must file paperwork with the U.S. Patent and Trademark Office in order to receive this right. The right extended by the Patent and Trademark Office exists for a limited time. Once it expires, no protection exists for the patent holder.
Research and Development Expenses
Companies acquire patents in one of two ways. The first way is by developing the product or process. The company’s employees spend their working hours experimenting until they find the right combination of materials to consider it a new invention worthy of a patent. The materials used throughout this development process represent an expense to the company. The labor costs incurred also represent an expense to the company. The company records these expenses by debiting "Research and Development Expense" and crediting "Cash" for the dollar amount spent.
The second method of acquiring a patent involves purchasing one from another company or individual. Acquiring a patent often involves legal expenses to formalize the contract. These legal expenses constitute part of the patent cost and are capitalized. The company calculates its total acquisition cost by adding the price paid for the patent and any legal fees incurred. This amount forms the basis for the patent in the accounting records. The company records this transaction by debiting "Patents" and crediting "Cash" for the total amount spent.
The balance maintained in the "Patent" account must be amortized over the life of the patent. This timeframe varies depending on how long the company expects to receive value of the patent and the length of time remaining on the patent registration. This timeframe may not exceed 20 years. At the end of each year, the accountant records an entry to amortize a portion of the balance in the patent account. The accountant divides the total cost of the patent by the number of years left of the patent’s life. This amount becomes the annual amortization amount. The company records the amortization by debiting "Amortization Expense" and crediting "Patent" for the amount.