Question

On January 1, 2005, Technocraft, Inc., acquired a patent that was used for manufacturing semiconductor-based electronic circuitry. The patent was originally recorded in Technocraft's ledger at its cost of $1,779,000. Technocraft has been amortizing the patent over an expected economic life of 10 years. Residual value was assumed to be zero. Technocraft sued another company for infringing on its patent. On January 1, 2012, Technocraft spent $180,000 on this suit and won a judgment to recover the $180,000 plus damages of $500,000. The sued company paid the $680,000. 1.Prepare the journal entry to record the award of $680,000 on January 1, 2012. 2. Indicate the entry you would have made had Technocraft lost the suit. (Assume that the patent would be valueless if Technocraft had lost the suit.) 3.What are the financial statement effects of capitalizing or expensing the cost of defending the patent? 4.Prepare the necessary journal entry on December 31, 2011. 5.Prepare the necessary journal entry on January 1, 2012, to record the expenditure of $180,000 to defend the patent.

Answer 1

Solution :

Desciption of Patents and concpets : ( some of the answers can be derived from the explanation)

Patent is a right conferred upon application to and approval by the federal government for the exclusive use of an invention.Patents may be purchased or developed internally The initial capitalised cost of a purchased patent is normally the fair value of the consideration given.

Subsequent to the grant of a patent, the owner need to defends a suit for patent infridgement..

The unrecovered costs of successful litigation are capitalized because they will benefit future periods. The costs of unsuccessful litigation are expensed out. it also indicates that the unamortized cost of the patent has no value and should be recognised as a loss.

1. Cash/Bank A/c .... Dr 680,000 ( reciept of money)

To Litigation (legal) Expenses 180,000 ( recovery of expenses already paid for )

To Revenue A/c 500,000 ( being damage claim recieved and recognised as revenue to be transferred to profit and loss)

2. If the patent would be valueless, the litigation expenses would be need to be expensed off. Also the balance amount on the patents account need to be written off since the value of the asset is now zero.

Book value of the patent as on 12/31/2011 = 1779000 * 3/10 = 533,400 ( from 2005 to 2011 for each of the years 177900 was expensed off).

Profit & Loss A/c .... dr 713,400 ( 533,400 + 180,000)

To Litigation expense 180,000 ( being expense transferred as loss)

To Patents ( Being assets written off)

3 & 4. If the defence was successful, the cost should be capitalised and written off over the remianing life of the patent. Patent A/c ..... Dr 180,000 To Litigation Expenses 180,000

If the defence was unsuccesful, the cost of defence along with the patent should be written off. refer journal entry1.

Altthough the judgement of the lawsuit was on 1st January ( assuming December is the year end ) , this event is subsequent item and the transaction needs to be recorded.