Preliminary expenses are the expenses incurred prior to incorporation of a Company or LLP, these are normally the expenses which founders/promoters of the company incur on account of government and professional fee paid to the consultant while incorporating the company. The project reports prepared to assess the viability of the business as such and the expenses incurred towards the brand building of the company while the incorporation process is underway.
The preliminary expenses are in the nature of expense which provides future economics benefits to the enterprise. But no physical or tangible assets are created or acquired according standard 10 deals with preliminary expenses according to that the expenses incurred towards startup activities which may consist of expenses incurred in establishing a legal entity such as legal fee, secretarial fee, govt fee, travelling and meeting expenses while the entity is under creation. The broader understanding is to include the following expenses under preliminary expenses.
- Meeting expenses of promoter.
- Preliminary consultation charges on formation of company.
- Actual Govt. fee and stamp duty paid in the course of incorporation of legal entity.
- Secretarial cost incurred for dealing with Registrar of Companies (ROC).
- Expenses to open new facility or business (pre opening cost).
- Training expenses incurred prior to incorporation of company.
- Expenses incurred towards human resources prior to incorporation.
- Expenses incurred towards any pre incorporation agreement.
- Project report and feasibility study related expenses etc.
It is clear from ever all the expenses which is required to make a legal entity operational (pre operational expenses) are grouped under preliminary expenses. The companies act and the income tax acts treats the preliminary expenses differently.
Companies Act Treatment
In view of facts that the preliminary expenses does not result into any physical or tangible assets, thereby taking away any possibility of depreciation to be recorded in the books. For the useful life of the assets. The Companies Act & Schedule VI provides for recognition of 1/5th of the total preliminary expenses each year for five consecutive years. To record this transaction following accounting entries are passed.
- To records the preliminary expense incurred prior to incorporation of the legal entity following entry should be passed on the first day of the incorporation : Debit the preliminary expenses A/c and Credit the Profit & Loss A/c for the amount determined as preliminary expenses.
- As stated above the preliminary expenses can be written off in five years, to record that following entry should be passed : Debit the Preliminary expenses written off the credit the preliminary expenses A/c with the amount which is equal to 1/5th of the total preliminary expense booked as per point no 1.
Income Tax Act Treatment
As explained above the preliminary expenses can be written off within five years however as per Section 35 of The Income Tax Act 1961, the total preliminary expenses cannot be more than 5 % of the capital employed, which can be amortised in five equal installments, this also means that a company cannot write off preliminary expense more than 1 % of the capital employed in one year. At the time of computation of the taxable income the assese must add the preliminary expense written off in the balance sheet which is prepared by following the provisions of The Companies Act 2013 and deduct the preliminary expenses as 1/5th of the 5% of the capital employed.
For More Details Visit Setindiabiz.com