Question

Morty Enterprises, is a new start-up company. Morty Enterprises has been preparing to begin operations for the past six months and is almost ready to start production. It has incurred significant costs but no revenue has yet to be earned. Organization costs such as legal fees and advertising have been capitalized as start-up costs. Morty Enterprises has expensed all payroll expenses, rent, and other similar costs as incurred—this has resulted in a significant loss being reported on the first year’s financial statements. Is Morty’s accounting treatment in accordance with GAAP?

This is an essay question, please answer it as detailed as possible. Thank you!

Answer 1

The rules concerning these cost are different for Income tax Purposes and Financial Reporting for US GAAP.

For those companies reporting under US GAAP, FInancial Accounting Standards Codification 720 states that Start up/ Organization costs should be expensed as incurred. However it is important to identify the cost as incurred because some particular cost may fall under other code sections and require special treatements.

Start Up Cost:It is defined as amount paid or incurred for creating an active trade or businesses or to investigate the creation or acquisition of an active tradeor businesses. Start up cost include:

• An analysis or survey of the potential markets, products, labor supply, transportation facility etc.
• Advertisements for the opening of the business.
• Salaries or wages for employees who are being trained and thier instructors.
• Travel and other necessary cost for securing prospective distributors , suppliers or customers.
• Salaries and fees for executives and consultants or for similar proffesional services.

Start up cost do not include:

• Cost related to obtaining licenses and other qualifications to get into the businesses.
• Cost of buying business assets such as building , equipment or vehicles.

Organizational Cost for Parntership or Corporations

Organizational Costs are expenses related to forming a corporation, parntership or limited liability company (Not sole proprietorship).These may include legal, management, consulting, accounting and filing fees.

The cost for isssuing and marketing interests in a partnership or corporation such as brokerage, registration and legal fees and printing costs do not qualify as organizational costs.

Start up costs and Organization Cost can be capitalized and amortized if they meet both of the following requirements.

1. You could deduct the cost if you paid or incurred them to operte an existing active trade or businesses( in same field).
2. You pay or incur the costs before the day your active trade or business begins.