NEW STANDARD ON ACCOUNTING FOR START-UP COSTS
By Joel Steinberg, CPA, American Express Tax and Business Services of New York, Inc.
n April 1998, The AICPA Accounting Standards Executive Committee (AcSEC) issued SOP 98-5,Reporting on the Costs of Start-Up Activities. The SOP is the second in a series of AcSEC projects dealing with the costs of activities undertaken to create future economic benefits. The first phase resulted in the issuance of SOP 93-7, Reporting on Advertising Costs.
The statement requires that costs of start-up activities, including organization costs, be expensed as incurred. AcSEC's conclusions are based in part on the fact that start-up costs are not specifically identifiable as assets, have indeterminate lives, are inherent in a continuing business, and are related to an enterprise as a whole. As stated in paragraph 24 of APB No. 17, Intangible Assets, costs meeting these conditions should be expensed as incurred. Additionally, assessments of the future economic benefits of such costs may be uncertain.
While some might not be pleased with the conclusions of the statement, it is clear that guidance in this area was long overdue. Industry practice with respect to start-up costs has varied, with some entities capitalizing start-up costs and others expensing such costs as incurred. In addition, amortization periods have varied among entities that capitalized start-up costs.
Definition of Start-up Activities
Start-up activities are defined broadly as those one-time activities related to opening a new facility, introducing a new product or service, conducting business in a new territory, conducting business with a new class of customer or beneficiary, initiating a new process in an existing facility, or commencing a new operation. Start-up costs are also referred to as preopening or preoperating costs.
The deferral of preopening costs was common in certain industries such as retail and restaurant. The deferred costs were limited to direct incremental costs of opening the facility, such as rent incurred in leasing a store prior to its opening and costs to set up the store and train personnel. Such costs were deferred if it could be demonstrated that probable future net operating results would be sufficient to recover the deferred costs. Deferral would cease when the facility commenced operations, and the deferred costs were typically expensed when the facility opened or over a period not exceeding one year. Under the provisions of SOP 98-5, all such costs will be expensed as incurred.
Prior to the effective date of this statement, it had been common industry practice to capitalize and amortize organization costs, typically over a five-year period. Organization costs include initial incorporation, legal, and accounting fees incurred in connection with establishing the entity. The statement now requires that organization costs be expensed as incurred. When the exposure draft was issued in April 1997, organization costs were excluded from the scope of the statement. However, in the end, AcSEC concluded that organization costs are similar to start-up costs and their exclusion from the scope of the SOP could not be justified.
Costs Outside the
Scope of the Statement
Certain costs incurred in conjunction with start-up activities are not covered by the SOP. The statement cautions, however, that this does not mean that all costs outside the scope of the SOP should be capitalized. Such costs should only be capitalized if they qualify for capitalization under other generally accepted accounting principles.
Costs of acquiring or constructing long-lived assets and getting them ready for their intended uses are excluded. However, costs of using long-lived assets allocated to start-up activities (for example, depreciation of computers) are within the scope of the SOP. Similarly, costs of acquiring intangible assets are excluded. However, the costs of using intangible assets that are allocated to start-up activities (for example, amortization of a purchased patent) are within the scope of the SOP. Costs related to internally developed assets (for example, internal-use computer software costs) are excluded unless such costs are allocated to start-up activities. Also excluded are costs of acquiring or producing inventory, research and development costs, costs of fund-raising incurred by not-for-profit organizations, advertising costs, and costs incurred in connection with construction contracts.
The statement does not apply to debt issue costs. Such costs continue to be deferred and amortized over the term of the related debt. The statement also does not apply to direct incremental costs of issuing securities (offering costs) that are deferred and deducted from the proceeds of the offering, as discussed in SEC Staff Accounting Bulletins (SAB) Topic 5A.
The appendix to the SOP provides examples of costs that are and are not within the scope of the statement. Illustration 2 provides an example of a retail chain that is constructing and opening two new stores. One will open in a territory in which the entity already has three stores, and the other will open in a new territory. Costs related to both openings are treated the same for the purposes of the SOP. The following are some of the costs that might be incurred in conjunction with start-up activities that are subject to the provisions of this SOP: salary-related expenses for new employees; salary-related expenses for the management store opening team; training costs and meals for newly hired employees; hotel charges, meals, and transportation for the opening team; security, property taxes, insurance, and utilities costs incurred after construction is completed; depreciation of new computer data terminals and other communication devices; and nonrecurring operating losses.
On the other hand, the following costs would be outside the scope of the SOP: coupon giveaways; costs of uniforms; costs of furniture and cash registers; costs to obtain licenses; security, property taxes, insurance, and utilities costs related to construction activities; and deferred financing costs.
Effective Date and Transition
The SOP is effective for financial statements for fiscal years beginning after December 15, 1998. Earlier application is encouraged, but restatement of previously issued financial statements is not permitted. Initial application should be reported as the cumulative effect of a change in accounting principle, as described in APB No. 20, Accounting Changes.
The SOP contains a special transition provision for investment companies such as mutual funds and hedge funds. These entities typically capitalize and amortize organization costs, as discussed in the AICPA Audit and Accounting Guide Audits of Investment Companies. AcSEC was concerned that because such entities report substantially all assets at market or fair value and issue and redeem shares or ownership interests at net asset value, the adoption of the statement would cause an immediate decrease in net asset value per share, thereby causing economic harm to such entities. Accordingly, these entities should not report the adoption of the statement as the cumulative effect of a change in accounting principle. Instead, they should apply the SOP prospectively for all costs incurred after June 30, 1998. Costs previously deferred should continue to be reported as assets and be amortized over the remainder of the amortization period. The unamortized balance of deferred start-up costs or organization costs and remaining amortization period should be disclosed.
Certain other SOPs and AICPA Audit and Accounting Guides also address start-up costs. This SOP amends those statements and guides to state that costs within the scope of SOP 98-5 should be expensed as incurred. *
Douglas R. Carmichael, PhD, CFE, CPA
John F. Burke, CPA
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