Treatment of Preliminary Expenses
Treatment of Preliminary Expenses
A company is a person brought to life by the law of the country. And in the process of bringing a company to life, real people invest their time and money. It means the company when it finally comes to existence, is already in debt to these people for that money they spent. These expenses are really extraordinary in nature because these happen only once in the lifetime of a company. Let's see what the Companies Act, 2013 and the Income Tax Act,1961 say about the accounting treatment of preliminary expenses.
What are Preliminary Expenses? Click here to know.
Now, before we get into the matter, let's rule out the fact that the preliminary expenses will result to obtain any physical value or become a tangible asset.
The Companies Act, 2013
Preliminary expenses aren't assets. They are neither tangible assets nor intangible assets. So, they can't be depreciated or amortized.
Rather, preliminary expenses should be treated as a normal expense, and expensed out in the year they are incurred. AS-26 issued by ICAI has held this as valid.
For example, if you pay Rs20,000 for preliminary expense in a year then please charge full Rs20,000 to profit and loss account. And don't capitalize even a single penny.
The Income Tax Act, 1961
The treatment isn't same in the case of The Income Tax Act, 1961.
Section 35D of Income tax Act directs to write off preliminary expenses in 5 years.
So, for income tax calculations, in the previous example, you can't expense full Rs20,000 in 1 year. You are allowed to expense Rs4,000 (viz 20,000/5) in one year.
In other words, deferred tax assets also come into picture.
