How Are Pre-Opening Costs Depreciated?

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Public officials allow entrepreneurs and new venture sponsors to circulate pre-opening business risks among a number of players, generally those who make up the lender or financier syndicate backing the venture. These exposures include market, credit and commodity risks. Regulatory agencies also allow sponsors to amortize -- not depreciate -- start-up costs over several years.

Answer

Pre-opening costs represent money an entrepreneur or business sponsor spends before a new venture starts operating. Also known as start-up expenses, pre-opening charges run the gamut from incorporation and legal fees to cash spent on business plan formulation, licenses and registrations. The Internal Revenue Service allows a new business to amortize start-up expenses, unlike financial accounting guidelines--which adopt a different conceptual stance. Generally accepted accounting principles and international financial reporting standards-- along with U.S. Securities and Exchange Commission edicts--mandate that a business record pre-opening costs as operating expenses.

Depreciation

The phrase "pre-opening cost depreciation” is technically incorrect, because accountants depreciate only fixed assets, also known as capital resources or long-term assets. Depreciation means spreading the cost of a resource over several years so revenue generated from the asset’s use matches expenses an owner incurs by utilizing the resource. Capital assets range from equipment and land to office equipment, production machinery and residential dwellings. Given that depreciable assets often constitute a substantial portion of a company’s balance sheet--especially in capital-intensive industries, such as mining and oil exploration--corporate management may ask that department heads continually monitor asset levels and generate better and more creative ideas to track and appraise these resources.

Amortization

To amortize pre-opening costs in fiscal filings, a business takes the total expense amount and spread it over the number of years the IRS and state revenue agencies have approved. For example, if the business spent $1 million before starting active trade and the IRS granted a 10-year allocation period, the annual amortization expense would equal $100,000, or $1 million divided by 10. The entry to record pre-opening expense allocation is: debit the amortization expense account and credit the start-up costs account.

Profitability Equation

By amortizing initial charges, a business takes the necessary record-keeping steps to publish accurate financial statements, monitors how much money it spends on operating activities as a whole, and resolves its profitability equation effectively. By doing so, the organization enables department heads to focus on growing operating activities, cutting costs in segments that consistently bleed money and reporting accurate performance data along the way.

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