Pre-operating costs include any expenses incurred during the startup or formation of a new business. They include expenses related to the investigation of a potential new business, as well as the actual costs associated with forming or registering the company. Generally, these costs are limited to only those expenses that would be treated as normal business expenses under standard accounting principles if the company were already in operation. This helps to prevent firms from deducting costs that are unrelated to the business, such as the purchase of a luxury car that is used to explore a few potential office sites for the new business. Pre-operating costs are also known as startup costs or pre-opening expenses.
All types of business entities may incur pre-operating costs. These expenses often include consulting fees that are paid to experts and advisors during startup. They may also include money paid to lawyers, who draft up corporate and partnership agreements, create company by-laws, and file articles of incorporation for new companies. Pre-operating expenses may also include accounting costs incurred while preparing to apply for a business loan, or when evaluating the credit worthiness of potential investors.
Fees paid to government agencies may also be included in pre-operating costs. New businesses often spend money filing for permits from city, state, and federal authorities. State agencies typically charge a fee when new businesses file for incorporation, or register a business trade name. Partners or directors of a new company can also include expenses related to meetings and planning sessions as part of cost calculations.
In terms of financial reporting, pre-operating costs are treated differently on tax forms than they are in the company's accounting records. International financial reporting standards require companies to treat pre-operating costs as expenses as these costs occur. If the company prepays for startup services, the costs must be treated as assets on the balance sheet until the service has been received. At this time, it is treated as an ordinary expense.
For tax purposes, pre-operating costs are treated as assets. Given that these costs are part of the business owner's initial investment, tax codes lump these costs in with the costs of equipment and other forms of capital. Some tax codes allow the business to deduct a small portion of these expenses when they are incurred, while the remainder are listed as assets on the balance sheet. This asset an then be amortized over time just like other types of assets.