Patents
A patent is a legal license granting its holder the exclusive right to make, use, or sell a specific invention. There are three types of patents. A utility patent is for processes, machines, and articles of manufacture. The light bulb and the Model T would have been utility patents. A design patent is used for any new, original ornamental design that can be affixed to an item of manufacture, such as a hood ornament for a Model T. A plant patent is granted to anyone that has invented or created a new plant, such as a unique strain of corn.
A patent is an example of an intangible asset with a limited life.
A patent is an example of an intangible asset with a limited life.
A U.S. patent currently lasts 20 years. Despite the fact that a patent is connected to a specific type of item, a patent represents a legal right and not a tangible item. A patent is classified as an intangible asset and is listed on a company's balance sheet.
Valuing a Patent
The value of a patent that a company would record on its books depends on how it acquired the patent. If the business developed the invention internally, all the research and development costs associated with that item would have been listed as an expense as those fees were incurred. Therefore, the initial value of an internally developed patent could be quite low.
If the business purchased the patent from the original holder, the value of the patent equals the acquisition cost.
The value of the patent may be increased if a patent holding company defends its rights to the invention in a lawsuit. If the company uses an outside law firm, all fees the business pays to the firm to defend the patent will be included as part of the patent's book value.
Amortizing a Patent
Since a patent is only valid for a limited number of years, a business is required to amortize it. The process of amortization requires decreasing the value of the asset annually by an amount equal to the value of the asset divided by the number of years of the patent's useful life. The useful life of the patent can be no longer than how much time is left on the patent's term, but should reflect the period that the underlying invention can generate revenue for the business that owns it. Every year the business records a decrease in the patent's value, it must also record a corresponding amortization expense equal to the decrease.
For example, assume a business acquires a patent that has 15 years left on its term for 1 million dollars. However, the invention the patent secures will only generate revenue for ten years. For the next ten years, the company must decrease the value of the asset by 100,000. To ensure the books are balanced, the business must also record a $100,000 amortization expense for the next ten years.