Question: A company buys a patent from an inventor on January 1, Year One, for $1 million to be paid
immediately. The accounting is straightforward; the patent is recognized as an intangible asset and reported at
the historical cost of $1 million. Accounting rules are clear on the handling of such acquisitions.
Assume, instead, that the company offers to pay this $1 million but not until five years have passed. The seller
agrees to that proposal. The purchase is made now but payment is delayed. Is the $1 million still being paid
solely for the patent? Does the entire $1 million reflect the historical cost of this intangible? What reporting is
appropriate if an asset such as a patent, building, or land is bought but payment will not take place for several
years? How is historical cost determined?
Answer: Approximately forty years ago, the authoritative accounting body at the time ruled that when cash is
paid for a purchase1 over an extended period of time in the future, there are always two distinct reasons for the
• The first is obviously the acquisition of the property such as the patent in this example.
• The second is interest. Interest is the charge for the use of money over time.
It was held to be unreasonable to believe that cash payments could be spread over several years without some
interest charge being factored into the negotiated amounts. The accounting here is based on that assertion.
In many purchases, interest is explicitly stated. For example, the contract to buy this patent could have required
payment of $1 million after five years plus interest at a 7 percent rate to be paid each year. Once again, the
accounting is not complicated. The $1 million is the historical cost of the patent while the annual $70,000
payments ($1 million × 7 percent) are recorded each year by the buyer as interest expense. The two amounts are
clearly differentiated in the terms of the agreement.