Question

At the beginning of the year, a company purchases a patent for $2,400,000. The remaining legal life of the patent is 12 years, but management estimates that the patent will generate additional revenue for the next 16 years because there are currently no known competitors. At the end of the first year, management calculates straight-line amortization to be $150,000 ($2,400,000 ÷ 16 years). Which of the following statements is correct?

Multiple Choice

a. Management should amortize the asset over 20 years.

b. Management should amortize the asset over 12 years.

c. Management should not amortize the asset until its useful life becomes more evident.

d. Management’s calculation is correct.

Answer 1

The correct amortization period for the patent is over its remaining legal life of 12 years, resulting in an annual amortization expense of $200,000, not the 16 years estimated by management.

Step-by-step explanation:

The correct statement with respect to the amortization calculation for the patent is that management should amortize the asset over 12 years, not the anticipated useful life of 16 years, in alignment with the legal life of the patent. The straight-line amortization method divides the cost of the patent by its legal life, providing the annual amortization expense.

Since patents are granted for a certain time period, typically 20 years, the patent's value as an intangible asset on the company's balance sheet should be amortized over its remaining legal life. In this case, despite management's estimate that the patent will generate revenue for 16 years, accounting principles dictate using the remaining legal life of 12 years for amortization purposes.

Therefore, the correct annual amortization expense should be calculated as $200,000 ($2,400,000 ÷ 12 years), not $150,000 as calculated by the management based on the anticipated useful life.