Question

Corp X has a patent with a book value of $4,000. Before its pending litigation, the company assumed a 3-year useful life of this patent with annual cash inflows of $3,000. After a judge awarded the company a decision defending its patent, the company new expectations increased the useful life of the patent to 5 years, its cash flow to $4,000 a year.

Please provide the accounting issues and how the company should account for this?

Answer 1

Patents are the intangible assets which needs to be ammortized based on its expected useful life and based on the annual cash flow it generates over the useful life. A general rule of ammortization is that it should be in proportion with the annual cash flow but in this case the cash flow is annually same so straight line ammortization is used for it.

In cases of patents any cost incurred to successfully defend the lawsuits and which adds value to the asset i.e either increase its annual cash flow or increase the useul life , is added to the cost of patents and ammortized over the revised remaining useful life.

In the given case, Corp X has a patent with a book value of $4,000 before its pending litigation the company assumed useful life of 3 years and annual cash flow of $3000 per year , so in this case the estimation of management is correct on this scenario regading the useful life and annual cash flow accordingly the management should ammortize the patents cost of $ 4000 in 3 years at equal amount.

However after the successful defending of patent the estimated useful life and aannual cash flow has increased which is very common , as this are termed as changes in accounting estimates and to be treated propectively in the year of change in estimate. Defending the case which result in increase in value and useful life will leads the asset to ammortoize over the revised remaining useful life.

If in any previous year amortization is made estimating 3 years of useful life then in current year amortization is to be made on the remaining useful life for the value of patents remaining estimating it is the new patent and to be ammortized over the remaining useful life equally.

Here the company should take the revised useful life of 5 years and ammortise the cost over the 5 years equally as annual cash flow is same, whatever charged before is ignored, the remaiing value is to be charged as per new estimated useful life as it is a change in estimates to be accounted prospectively.

The journal to record the amortization by debiting the amortization expenses and credting the patents value.