FAR · Select balance sheet accounts · 6 practice questions
Patent and trademark costs: capitalize vs expense (GAAP)
Capitalize the purchase price and directly attributable costs to obtain or successfully defend a specific identifiable intangible; expense R&D, advertising, start-up, training, and unsuccessful defenses. Below: sort tricky items across three buckets with short reasons.
Try one first
Hint
Separate the costs of creating the idea from the costs of legally obtaining and protecting the patent.
Answer B. Under U.S. GAAP, research and development costs are expensed as incurred. Costs to obtain a patent (legal and filing fees) and legal fees for a successful defense of the patent are capitalized, so Lark should capitalize $16,000 + $34,000 = $50,000.
Why not A: This reflects the incorrect view that all costs related to internally developed intangibles are expensed; legal/filing fees to secure and successfully defend a patent are capitalized and thus not $0.
Why not C: This selects only the patent application costs but ignores the legal fees from the successful defense, which are capitalized and should be added to the carrying amount.
Why not D: This sums all costs including R&D. R&D costs are expensed and are not included in the patent's carrying amount, so $290,000 is incorrect.
Sort it
Costs that directly obtain or successfully defend a specific finite-lived legal right, or capitalizable internal-use software application-development costs.
Costs that directly obtain, register, or successfully defend an identifiable intangible with no foreseeable limit on useful life.
R&D, advertising/brand-building, start-up/organization, training, preliminary or post-implementation software costs, routine maintenance, and unsuccessful defenses.
| Item | Goes to |
|---|---|
| Legal and government filing fees to obtain a patent for an internally developed process | Capitalize to the intangible (finite-lived; amortize)Directly attributable to obtaining a specific legal right. |
| Internal R&D costs to develop the process underlying that patent | Expense immediatelyR&D is expensed under GAAP. |
| Legal fees in a successful defense of a purchased patent | Capitalize to the intangible (finite-lived; amortize)Successful defense preserves rights; add to carrying amount and amortize over remaining life. |
| Legal fees in an unsuccessful patent defense | Expense immediatelyUnsuccessful defense costs are not capitalized. |
| Advertising to launch a new product that uses the patent | Expense immediatelyAdvertising and promotion are period expenses. |
| Purchase price of a customer list acquired from a broker | Capitalize to the intangible (finite-lived; amortize)Purchased identifiable intangible; amortize over its useful life. |
| Purchase price and registration fees for a trademark expected to be renewed indefinitely | Capitalize to the intangible (indefinite-lived; do not amortize)Direct acquisition and registration costs of an indefinite-lived intangible. |
| National advertising to strengthen that purchased trademark | Expense immediatelyBrand-building costs are expensed. |
| Legal fees to successfully defend an indefinite-lived trademark | Capitalize to the intangible (indefinite-lived; do not amortize)Successful defense costs are added to the trademark; it remains unamortized while indefinite-lived. |
| Internal-use software coding and testing in the application-development stage | Capitalize to the intangible (finite-lived; amortize)Application-development stage costs are capitalizable. |
| Preliminary project-stage costs for that software | Expense immediatelyPreliminary stage is expensed under GAAP. |
| Training costs for the software after implementation | Expense immediatelyTraining and post-implementation costs are expensed. |
| Research to develop new uses for an acquired patent | Expense immediatelyResearch and development are expensed as incurred. |
| Start-up and organizational costs to open a new division | Expense immediatelyStart-up/organization costs are period expenses under GAAP. |
Key points
- Add successful legal-defense costs to the existing intangible and amortize over the remaining useful life if the asset is finite-lived.
- Legal and registration fees to acquire or register a patent or trademark are included in the asset’s cost.
- Internal R&D is expensed even if it relates to a recognized patent or trademark.
- Advertising and brand strategy costs are expensed; they do not become part of a trademark or patent.
- Indefinite-lived trademarks are not amortized; if the life becomes finite, test for impairment immediately before reclassification, then amortize prospectively.
- Internal-use software: capitalize application-development stage; expense preliminary and post-implementation (training/maintenance).
How the exam traps you
- Capitalizing advertising or market-creation spend into a trademark or patent. Expense advertising, branding, and promotion as incurred; only legal acquisition/registration and successful defense costs are capitalized.
- Amortizing an indefinite-lived trademark. Do not amortize while indefinite; test for impairment at least annually. If the life becomes finite, test for impairment first, then amortize prospectively.
- Including R&D costs in a patent’s carrying amount. Expense internally incurred research and development, even if it relates to a purchased or internally developed patent.
- Expensing successful legal defense costs. Capitalize successful defense costs to the existing intangible and amortize over its remaining useful life (if finite-lived).
Question 2
| Expenditure | Amount |
|---|---|
| Purchased a trademark from an unrelated party | $400,000 |
| Attorney and registration fees to register the trademark | $15,000 |
| Advertising to introduce the new brand | $80,000 |
| Research and development costs for a new product line | $90,000 |
| Coding and testing internal accounting software (application development stage) | $150,000 |
| Purchased a patent | $120,000 |
| Legal fees to successfully defend the patent | $25,000 |
Hint
Identify which costs are direct acquisition/defense or application-development-stage software costs (capitalizable) versus routine advertising or R&D (expensed).
Answer B. Under U.S. GAAP, the cost to purchase intangible assets and directly attributable costs to acquire, register, or successfully defend them are capitalized. Internal-use software costs incurred during the application development stage are capitalizable. Advertising costs and research and development costs are generally expensed as incurred and are not capitalized as intangible assets.
Why not A: This is tempting because some candidates think only the purchase price is capitalized. However, directly attributable acquisition costs (such as registration or successful defense legal fees) are included in the asset's cost, and qualifying internal-use software development costs (application development stage) are capitalizable.
Why not C: This attracts candidates who view advertising and R&D as investments in future benefit, but under U.S. GAAP advertising costs are typically expensed when incurred and R&D costs are expensed as incurred rather than capitalized as intangible assets.
Why not D: This choice is tempting if one assumes every cost that increases future value is capitalizable. It's incorrect because advertising and R&D are typically expensed; only qualifying internal-use software costs (application development stage) are capitalized, and directly attributable acquisition/defense costs are capitalized for purchased intangibles.
Question 3
Hint
Ask whether the item was acquired from an external party and whether GAAP specifically requires expensing (R&D/advertising) or allows recognition as an acquired intangible.
Answer A. Identifiable intangible assets acquired from an external party (for example, a purchased patent) are recognized on the balance sheet at cost and subsequently amortized over their useful life (unless indefinite). This contrasts with internally generated goodwill and most R&D and advertising costs, which are generally expensed under US GAAP.
Why not B: This is tempting because goodwill represents future economic benefits, but internally generated (self-created) goodwill is not recognized under US GAAP. Only goodwill acquired in a business combination is recorded as an asset.
Why not C: While R&D may create future value, ASC 730 generally requires that R&D costs be expensed as incurred; capitalization is limited to specific exceptions (for example, certain internal-use software costs), so typical R&D is not recorded as an intangible asset.
Why not D: Advertising and promotion costs are ordinarily expensed as incurred under US GAAP, even though they may increase brand value in reality. (Direct costs to register or defend a trademark may be capitalized, but routine advertising costs are not.)
Question 4
Hint
Focus on what the legal action actually accomplishes for the patent right, not on the size of the fees or how the patent was originally obtained.
Answer C. For legal costs incurred to defend a patent, the key factor is whether the defense is successful. If the defense successfully preserves the patent rights, the costs are capitalized because they protect the future economic benefits of the patent. If the defense is unsuccessful, the costs are generally expensed as incurred.
Why not A: Candidates may associate capitalization with extending useful life, but defense costs can be capitalized even if they do not extend the patent's legal life. The governing issue is whether the defense preserves the existing right and its future benefits, not solely life extension.
Why not B: While acquisition method affects initial recognition of intangibles, it is not the primary factor for defense costs. For defending an existing patent, GAAP focuses on the outcome of the defense (successful preservation) to decide capitalization versus expense.
Why not D: Materiality or size might influence disclosure judgments, but they do not determine the basic accounting treatment. The required treatment depends on the result of the defense, not how large the fees are relative to income.
Question 5
Hint
Focus on which cost preserves or acquires a legally protected intangible right, rather than merely supporting future benefits.
Answer A. Legal fees to successfully defend a patent are capitalized as part of the patent's cost because they preserve the asset's legal rights; the capitalized amount is then amortized over the patent's remaining useful life. By contrast, costs that create or support goodwill, brands, research, or employee capability are generally expensed as incurred under U.S. GAAP.
Why not B: Tempting because trademarks are intangibles, but advertising and promotion costs to develop or launch an internally generated brand are generally expensed as incurred rather than capitalized as an intangible asset.
Why not C: This is attractive since research might lead to a valuable formula, but under U.S. GAAP research and development costs are generally expensed when incurred and are not capitalized as an intangible asset.
Why not D: Training may produce future benefits but it does not create a separable intangible asset under GAAP; therefore employee training costs are expensed as incurred.
Question 6
Hint
Separate costs to acquire the patent itself from costs to research or develop products that may use it.
Answer D. A purchased patent is recorded at cost, which includes the purchase price and directly attributable acquisition costs such as legal and registration fees. Therefore Alder should capitalize $500,000 + $25,000 = $525,000. The $75,000 of research costs are expensed as incurred and are not capitalized into the purchased patent.
Why not A: This reflects only the purchase price and omits directly attributable acquisition costs; legal and registration fees incurred to acquire and secure the patent are capitalized and should be added to the patent's cost.
Why not B: This sums all three amounts and therefore capitalizes research costs as well as acquisition costs. Research spending should be expensed, so only the purchase price and acquisition-related legal/registration fees belong in the patent carrying amount.
Why not C: This amount treats the $75,000 of research as part of the patent cost. Research and development costs are expensed as incurred under U.S. GAAP and should not be capitalized to a purchased patent.
Common questions
Are legal fees to defend a patent capitalized or expensed?
Capitalize them only if the defense is successful in preserving the patent rights. If the defense is unsuccessful, expense the costs and assess the patent for impairment if needed.
Can advertising or branding costs be capitalized into a trademark?
Generally no. Advertising, promotion, brand strategy, and logo design costs are expensed. Only legal and registration costs to obtain or successfully defend the trademark are capitalized.
What happens if an indefinite-lived trademark will only be used for a limited period going forward?
On the decision date, test the trademark for impairment as an indefinite-lived asset. Then reclassify to finite-lived and amortize prospectively over the remaining useful life.
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