What it means
The bargain at the heart of a patent is disclosure for protection. The state grants a temporary monopoly over the invention, and in return the applicant describes it fully enough that a skilled person could reproduce it once protection expires.
Not every good idea can be patented. The invention generally has to be new, involve a genuine inventive step rather than an obvious tweak, and be capable of industrial application, which is why business methods and abstract ideas are so often refused.
The accounting treatment depends on how the patent was obtained. Costs of buying a patent from someone else are capitalised as an intangible asset, whereas the internal research that produced an invention is usually expensed as incurred, so a company's most valuable patents frequently carry almost no book value.
Once capitalised, a patent is amortised over the shorter of its remaining legal life and its useful economic life. Useful life is often the shorter of the two, because a competing technology can make an invention commercially worthless long before the twenty years run out.
Patents also cost money to keep. Renewal fees fall due periodically in every country where protection is held, and enforcement is entirely down to the owner, so a patent is only as strong as the willingness and budget to defend it in court.
In practice
Real-world examples
Example 1
A battery start-up files a patent covering an electrode coating process. The application costs about $45,000 across three jurisdictions, and although the internal research is expensed, the protection is what allows the company to raise a funding round at a credible valuation.
Example 2
A packaging manufacturer buys a portfolio of four patents from a company leaving the market for $800,000. Its accountants capitalise the purchase and amortise it over the nine years of protection remaining on the shortest patent in the group.
Example 3
A pharmaceutical firm watches a key patent approach expiry and models the revenue cliff that follows, when generic competitors enter and the price of the drug typically falls sharply. Planning for that date shapes the research budget years in advance.
Think of it
A patent is like holding the only legal title deed to a house on a busy street. Even though you cannot physically hold the legal right in your hands, it stops anyone else from moving in, and lets you charge rent to anyone who wants to use your space.
Formula
Calculation
Annual amortisation = Capitalised patent cost / Remaining useful life in years
Carrying value = Capitalised cost - Accumulated amortisation
A medical devices company buys a patent covering a catheter design for $240,000. The patent was filed eight years ago, so twelve years of its twenty-year legal life remain, and management judges that the commercial life is also about twelve years.
Annual amortisation is $240,000 / 12 = $20,000, charged to the income statement every year. After five years accumulated amortisation is $20,000 x 5 = $100,000, so the carrying value on the balance sheet is $240,000 - $100,000 = $140,000. If a rival technology made the design obsolete in year six, the company would test the asset for impairment and could be required to write the remaining $140,000 down well ahead of schedule.Case study
Seen in the real world
Ardenlow Instruments is a fictional and purely illustrative maker of laboratory pumps, used here to show how patents behave on the balance sheet. It held two patents developed in house, which carried no book value because the research had all been expensed, and one purchased patent recorded at $240,000.
An acquirer valuing Ardenlow initially focused on the balance sheet and concluded that the intellectual property was worth $240,000. A technical review told a different story: the two internally developed patents protected the seal design behind 70% of the company's gross profit, while the purchased patent covered a product line that had been discontinued two years earlier and was already impaired in substance.
Ardenlow's finance director wrote the purchased patent down to nil and commissioned an independent valuation of the two in-house patents to support the sale discussion. The illustrative lesson is that the book value of a patent reflects how it was acquired rather than what it is worth, so anyone assessing a technology business has to look past the intangible asset line.
Watch out
Common mistakes
- Assuming a patent guarantees the right to sell a product, when it only grants the right to stop others, and a product can still infringe someone else's earlier patent.
- Believing the balance sheet shows what a company's patents are worth, when internally generated ones usually carry no book value at all.
- Forgetting that renewal fees and enforcement costs continue for the life of the patent, so an unused portfolio quietly drains cash.
Questions
People also ask
How long does patent protection last?
Typically twenty years from the filing date, provided renewal fees are paid, although protection is granted country by country rather than globally.
Should patent application costs be capitalised?
Legal and registration costs directly attributable to obtaining the patent are usually capitalised, while the underlying research that produced the invention is normally expensed.
Is a patent worth having for a small company?
It can be, particularly when raising money or licensing, but the cost of filing in multiple countries and the practical difficulty of enforcement mean some firms rely on trade secrecy instead.