Capitalizing vs Expensing Patent Costs: Financial & Tax Impacts

The duration of this protection is typically 20 years from the filing date of the patent application, thereby allowing the company time to recoup its investment. During this period, the costs of maintaining the patent—through renewal fees—fall on the company to ensure ongoing exclusivity. Legal fees and registration costs are the initial outlays a biotechnology company must consider when filing a patent. Legal fees can be substantial, often involving costs for patent attorneys who prepare and prosecute the patent application. The journey from application to grant includes expenses related to search and examination fees, as well as potential costs for responding to office actions and amendments.

Accounting Treatment for Patents

The significant non-cash investing activities are, however, disclosed in the footnotes under the caption “non-cash investing and financing activities”. For tax purposes, there are two options for amortization of intangibles that the IRS allows. The income forecast method can be used instead of the straight-line method if the asset is motion picture films, videotapes, sound recordings, copyrights, books, or patents.

Patents

• The amortization of the patent is recorded as a series of journal entries, which allocate the cost of the patent over its useful life.
• Companies should take into account the cost of the patent, the useful life of the patent, and the impact the patent will have on the business when amortizing a patent.
• This is because patents have a finite life and their value is heavily dependent on the legal protection period, after which the patented information becomes public domain.
• Under accrual accounting, the “objectivity principle” requires financial reports to contain only factual data that can be verified, with no room for subjective interpretation.

If this pattern cannot be reliably determined, a straight-line method is applied, which evenly distributes the cost over the useful life. The strategy for amortization of a patent begins once it is capitalized as an intangible asset. The useful life of the patent is determined, which is either the time period the patent is expected to generate revenue or its legal life, whichever is shorter. Biotech companies must choose an amortization method that best reflects the patent’s consumption of economic benefits.

Amortization of intangible assets:

The straight-line method is commonly used due to its simplicity and consistency, allocating the cost evenly over its useful life. When a company acquires or develops a patent, it must determine how to properly recognize this intangible asset within its financial statements. Patent costs are recognized as intangible assets when they provide future economic benefits through their exclusivity rights. The costs incurred to acquire or register a patent can be capitalized if they meet the criteria for asset recognition.

A reduction, on the other hand, signifies that the asset has been sold during the period. Such acquisitions and sales of long-term or fixed assets are known as investing activities. The rest of this article explains how inflows and outflows of cash caused by such activities are computed and reported in the statement of cash flows. When it comes to patent amortization, the legal considerations are as multifaceted as they are critical.

Actual market worth is the quantity the property can sell for on the open market. After goodwill is calculated, estimate the useful lifetime of goodwill and amortize the intangible asset. Cash flow statements are one of the most critical financial documents that an organization prepares, offering valuable insight into the health of the business. By learning how to read a cash flow statement and other financial documents, you can acquire the financial accounting skills needed to make smarter business and investment decisions, regardless of your position. Cash flow is broken out into cash flow from operating activities, investing activities, and financing activities.

By expensing the cost of the asset over a period of time, the company is complying with GAAP, which requires the matching of revenue with the expense incurred to generate the revenue. The amortization expense reduces the appropriate intangible assets line item on the balance sheet—or in one-time cases, items such nonqualified deferred compensation plan faqs for employers as goodwill impairment can affect the balance. From a tax authority’s point of view, the emphasis is on the legality and correctness of the amortization claims. Tax laws often have specific provisions regarding the amortization of intangible assets, and these can significantly affect the amount of tax payable.

The company opts for an accelerated amortization method, which reduces its taxable income in the early years when revenue from the patent is high. As technology progresses and the patent’s value diminishes, the company reassesses and switches to a straight-line method, smoothing out the expenses over the remaining useful life. From an accountant’s perspective, the focus is on ensuring compliance with accounting standards such as the international Financial Reporting standards (IFRS) or generally Accepted Accounting principles (GAAP).