Consider the following two scenarios:
Scenario I: Over the 20X1–20X5 period, Micro Systems, Inc., spends $10 million a year to develop patents on new computer hardware manufacturing technology. While some of its projects failed, the firm did develop several new patents each year during the period.
Scenario II: Over the 20X1–20X5 period, Macro Systems, Inc., a competitor of Micro Systems, Inc., paid $10 million each year to acquire patent rights from other firms. The firm assigned a five-year useful life to all of the patents.
a. Each firm had sales of $200 million, $242 million, $290 million, $350 million, and $400 million, respectively, over the 20X1–20X5 period.
b. Each firm’s operating expenses (excluding the preceding patent-related information) were $140 million, $170 million, $205 million, $245 million, and $265 million, respectively, over the 20X1–20X5 period.
c. Assume that a 21% income tax rate applies to both firms.
Required:
1. How would the two firms account for their patent-related expenditure?
2. Calculate each firm’s net income and net income as a percent of sales (that is, profit margin) for the 20X1–20X5 period. Contrast the reported profitability of the two firms.
3. Assume that the firms continue to spend $10 million per year in the way just described. How would the comparability of their income statements and balance sheets be affected?
