The expenses incidental to the formation of a company are termed preliminary expense.The cost of printing and circulating the memorandum and articles of association and prospectus ,the registration charges and stamp duties, the printing or share certificate,legal charges are included under preliminary expenses. Preliminary expense are a sort of capital expenditure which may be written off over a period of years.
Examples of Preliminary Expenses
- The charges paid top Chartered accountant for forming a business.
- Expense paid for printing of memorandum & article of association and its circulation charges.
- Any legal charges paid before incorporation.
- Amount paid for stamp duties
- Expense in connection with marketing survey or feasibility study.
- Professional and consulting charges paid for the incorporation of company.
Accounting for preliminary Expenses
Normally preliminary expense are treated as intangible asset and shown on the asset side of the balance sheet under the head Miscellaneous asset. The preliminary expenses are amortized or written off in five years for the purpose of Income Tax in India. How ever Accounting standard 26 says a period 10 years for writing off intangible asset. There is no other legal restriction for writing off. If management decide to write off all expense in the very first year, company can do so.
If the amount of preliminary expenses is small, it may be debited to P&L account.If the amount is large it may be spread over a number of years; the portion which applied to the current year is debited P&L. Account and the balance is shown on the balance sheet.
Accounting Entries for Preliminary Expenses:
Preliminary Expense Incurred
- Preliminary Expense – Debit (Current Asset)
Cash – Credit
Preliminary expense Written off entry
- Preliminary Expenses Written Off – Debit (Indirect Expenses)
Preliminary Expenses – Credit
- Profit & Loss A/c. – Debit
Preliminary Expenses -Credit
Apart from preliminary expense, there are expenses called pre-commencement expenses which are incurred right before the commencement of business but after the incorporation. This expense are treated as indirect expense and charged to Profit and loss account in the same year. For example staff recruiting expenses.