Patent Impairment

Patents must be tested for impairment periodically and declared as ‘impaired’ if necessary. In plain English, a patent is impaired if it would sell for less than the value shown in the company records. Patent impairment occurs when the carrying amount of a patent on a company’s balance sheet exceeds its recoverable amount indicating that the patent’s economic value has declined. The decline can be due to various causes such as technological obsolescence, legal challenges, market changes or reduced economic benefits from the patent. The thing all these causes have in common is that they are unexpected – this is a defining feature of impairment in accounting, i.e. it is not something that can be planned for. When impairment is identified, the patent’s value is then ‘written down’ to a new lower recoverable amount as an ‘impairment loss’. This is recorded as an expense on the income statement and the decreased value of the asset is now recognized on the overall balance sheet.

Practical Example

A company develops a novel technology and files for a patent. The direct costs incurred during the development phase amount to $500,000. Upon receiving the patent, the company records this amount as an intangible asset. Assuming the patent’s useful life is estimated to be 15 years, the company will amortize the $500,000 over 15 years resulting in an annual amortization expense of $33,333.  If after 5 years, changes in the market conditions indicate the patent might be impaired and the company tests for impairment. Suppose the recoverable value is determined to be $100,000, but the carrying amount after 5 years of amortization is $333,333. The company would recognize an impairment loss of $233,333 ($333,333 – $100,000).

Patent Value

Accounting for the value of patents involves several steps and methodologies. Companies use different techniques to assess the fair value of their patents, they include:

• Cost Approach: The actual cost incurred to develop or acquire the patent.
• Market Approach: Comparing the patent with similar patents that have been sold or licensed in the market.
• Income Approach: Estimating future cash flows expected to be generated by the patent and discounting them to present value.

Pelent Methodology

Business Value is a key criterion in Pelent’s AI algorithm; it is an indicator whether a patented invention is used in the industry and that it has significant revenue attached to its use. A granted patent is no guarantee that the invention has Business Value in fact most patents will never achieve significant commercial relevance. We premise that litigated patents inherently have strong Business Value. Patent litigation is notoriously expensive – lawyers and experts spend hundreds and perhaps thousands of hours searching technical papers, poring over the patent specifications and prior art to produce strong Evidence-of-Use along with associated assertion arguments. While not every valuable patent is litigated, the correlation is strong enough to use litigated patents as a proxy for valuable ones. The premise is inherently powerful, essentially incorporating both the Market Approach and the Income Approach criteria;  a) Market Approach by comparing each patent to similar ones that have been licensed in the market and b) Income Approach since litigated patents are expected to generate significant future cash flows. Pelent’s valuation methodology essentially combines the best of both approaches.

Wrapping Up

A portfolio checkup is a valuable tool for evaluating patents. The process is quick and cost-effective, delivering an accurate and quantitative assessment. Accounting for patents involves recognizing their cost, amortizing over their useful life, testing for impairment, and optionally revaluing them.  Proper disclosure ensures transparency for stakeholders; a portfolio checkup allows accounting teams and portfolio managers to hone into low value assets and declare impaired patents as necessary.