Organization Costs

Definition

The financial accounting term organization costs refer to those expenditures incurred during the formation and launch of a corporation.  Organization costs can include legal payments, state and federal registration and incorporation fees, promotions, and charges associated with the underwriting of stocks and bonds.

Organization costs can be classified as assets on the company's balance sheet.

Explanation

A business may incur a number of costs as it is forming or during launch.  These are considered the "costs of doing business" and are not related to the operation of the company.  For example, a company might pay attorney and state fees when registering as a corporation.  If the company decides to issue common stock or bonds, underwriting fees are also considered organization costs.

Accounting rules allow companies to categorize these costs as an asset on the balance sheet, and amortize them over a maximum of 40 years.  Typically, companies choose to amortize them over relatively short timeframes (5 to 10 years).

According to FASB No. 7, operating losses incurred in the early stages of startup cannot be capitalized.  Paragraph 10 states the following:

"Generally accepted accounting principles that apply to established operating enterprises shall govern the recognition of revenue by a development stage enterprise and shall determine whether a cost incurred by a development stage enterprise is to be charged to expense when incurred or is to be capitalized or deferred."

Current tax law also allows for the capitalization of these costs.  To qualify, the cost must meet all four of the following rules:

  • They must be associated with the creation of the corporation.
  • Charged to a capital account.
  • Amortized over the life of the corporation (if the corporation is determined to have a fixed life).
  • Incurred before the end of the first tax year in which the corporation is in business.

If the company is using the cash method of accounting, they can amortize their organizational costs incurred in the first tax year, even if the costs are not paid in that same year.  Examples provided by the IRS include:

  • The cost of organizational meetings and temporary directors
  • State incorporation fees
  • Legal services

Since tax rules require companies to amortize the above costs over at least five years, companies typically choose to align the tax amortization approach with that used on the balance sheet.

Related Terms

balance sheet, corporation, amortization, income taxes