Preliminary Expenses

Definition

Preliminary Expenses refer to the initial costs incurred during the setting up of a company. These expenses are often incurred prior to the commencement of business operations and typically include costs associated with legal fees, company registration, issuing shares, and promotional activities. These expenses may be written off to the share premium account, which is an account used to record the extra amount received over the nominal value of shares.

Examples

Legal Fees: Costs incurred for legal services related to company formation, including the preparation and filing of articles of incorporation.
Registration Fees: Payments made to governmental authorities for the registration and licensing of a new company.
Issuing Shares: Costs associated with the initial issuance of shares, including underwriting fees and printing costs.
Promotional Expenses: Marketing and advertising costs aimed at promoting the newly formed company to potential shareholders and the public.

Frequently Asked Questions (FAQs)

Q1: Can preliminary expenses be capitalized?

A1: Preliminary expenses are typically treated as intangible assets and may be capitalized over a period, depending on the accounting standards followed. They are often amortized over their useful life.

Q2: How are preliminary expenses treated under IFRS?

A2: Under International Financial Reporting Standards (IFRS), preliminary expenses cannot be capitalized and must be expensed as they are incurred.

Q3: Are preliminary expenses tax deductible?

A3: In many jurisdictions, preliminary expenses may be tax deductible, either immediately or over a specified period. The specific treatment depends on local tax laws and regulations.

A4: A share premium account is an equity account that records the amount received by a company over and above the nominal value of its shares during issuance.

A5: Writing off preliminary expenses to the share premium account is a way to utilize the excess funds received from shareholders, ensuring that these costs do not impact the company’s profit and loss statement.

Share Premium Account: An account used to record the amount received over the nominal value of shares issued.
Amortization: The process of gradually writing off the initial cost of an intangible asset over its useful life.
Incorporation Costs: Expenses incurred during the process of legally registering a new company with the relevant authorities.
Seed Capital: The initial funding used to cover preliminary expenses and start a new company.
Prospectus: A formal document issued by a company to potential investors, outlining financial details and risks associated with buying shares.

Online References

Investopedia: Preliminary Expenses
International Financial Reporting Standards: IFRS
Corporate Finance Institute: CFI Articles on Corporate Finance

Suggested Books for Further Studies

Financial Accounting and Reporting by Barry Elliott and Jamie Elliott
Intermediate Accounting by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
Principles of Corporate Finance by Richard A. Brealey, Stewart C. Myers, and Franklin Allen
Managerial Accounting by Ray H. Garrison, Eric Noreen, and Peter C. Brewer
Accounting Principles by Jerry J. Weygandt, Paul D. Kimmel, and Donald E. Kieso

Accounting Basics: “Preliminary Expenses” Fundamentals Quiz

### What are preliminary expenses associated with? - [ ] Ongoing operational costs - [ ] Employee salaries - [x] Costs incurred during the setting up of a company - [ ] Dividends to shareholders > **Explanation:** Preliminary expenses are initial costs incurred during the establishment of a company, such as legal fees, registration fees, and issuing shares. ### How can preliminary expenses be written off? - [ ] Directly from revenue - [x] To the share premium account - [ ] As liabilities - [ ] As accrued expenses > **Explanation:** Preliminary expenses can be written off to the share premium account, utilizing the extra funds received over the nominal value of shares. ### Under IFRS, how should preliminary expenses be treated? - [ ] Capitalized - [x] Expensed immediately - [ ] Written off as liabilities - [ ] Added to assets > **Explanation:** Under IFRS, preliminary expenses must be expensed as they are incurred and cannot be capitalized. ### Which of the following is an example of preliminary expense? - [x] Legal fees for company registration - [ ] Utility bills - [ ] Inventory costs - [ ] Office supplies > **Explanation:** Legal fees for company registration are an example of preliminary expenses incurred during the setup of a company. ### Are preliminary expenses tax deductible? - [x] Yes, depending on jurisdiction - [ ] No, they are never deductible - [ ] Only if capitalized - [ ] Only if written off immediately > **Explanation:** Preliminary expenses may be tax deductible in many jurisdictions, either immediately or over a specified period, depending on local tax laws. ### What does a share premium account record? - [x] The amount received over the nominal value of shares issued - [ ] The par value of all shares issued - [ ] The inventory of shares - [ ] Expenses paid to shareholders > **Explanation:** A share premium account is an equity account that records the amount received by a company over and above the nominal value of shares issued. ### Why would a company write off preliminary expenses to the share premium account? - [ ] To increase cash reserves - [ ] To misuse excess funds - [x] To ensure preliminary costs do not impact the profit and loss statement - [ ] For tax evasion > **Explanation:** Writing off preliminary expenses to the share premium account ensures that these costs do not impact the company's profit and loss statement. ### What is the purpose of amortization in the context of preliminary expenses? - [ ] To increase liabilities - [ ] To write off operational costs - [ ] To convert expenses into dividends - [x] To gradually write off the initial cost of an intangible asset over its useful life > **Explanation:** Amortization is used to gradually write off the initial cost of an intangible asset, such as preliminary expenses, over its useful life. ### How do preliminary expenses differ from ongoing operational costs? - [x] Preliminary expenses are incurred before business operations begin - [ ] Both are incurred after commencement of business - [ ] Preliminary expenses are higher - [ ] They are the same > **Explanation:** Preliminary expenses are incurred before the commencement of business operations, whereas ongoing operational costs are incurred after the business starts functioning. ### What is the significance of proper accounting for preliminary expenses? - [x] Ensures accurate financial reporting and compliance with standards - [ ] Hides costs from investors - [ ] Manipulates financial outcomes - [ ] Makes accounting simpler > **Explanation:** Proper accounting for preliminary expenses ensures accurate financial reporting and compliance with relevant accounting standards and regulations.

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