Resolved: Start-Up Costs Are Not Assets

Entities should expense start-up costs as they are incurred. The conclusion seems simple enough: The costs of start-up activities, including organization costs, should be expensed as they are incurred. But how easy will entities find it to apply this new rule by the AICPA's AcSEC? In April 1998, AcSEC issued SOP 98-5, Reporting on the Costs of Start-Up Activities, which applies to all nongovernment entities. Most entities are required to adopt the SOP for fiscal years beginning after December 15, 1998, except for certain investment companies, which were required to adopt it as of June 30, 1998. (See Official Releases, page 99, for the text of the SOP). This article addresses some of the possible confusion about what SOP 98-5 does and does not cover. START-UP ACTIVITIES DEFINED SOP 98-5 defines start-up activities as one-time activities an entity undertakes when it opens a new facility, introduces a new product or service, conducts business in a new territory or with a new class of customer or beneficiary, initiates a new process in an existing facility or commences some new operation. After considerable research and discussion, that's the best definition anyone could come up with. That said, the final definition is broad and might appear to overlap with activities related to buying or building certain assets, such as fixed assets and inventory--comments on the exposure draft of the SOP highlighted some of the confusion. One provision of the SOP is worth stressing: Costs that entities previously capitalized as start-up costs should now be expensed as they are incurred. So, if Joe's Retail Co. has start-up costs of $1 million on its balance sheet, it should expense the entire $1 million immediately upon adopting SOP 98-5 and then expense all such costs as they are incurred in the future. START-UP COSTS VS. FIXED ASSETS Certain costs an entity incurs in conjunction with start-up activities may, in fact, be costs related to the construction of, say, a plant. How should a CPA distinguish between one-time activities related to opening a new facility (startup) and activities to get a plant constructed and ready for its intended use (fixed asset)? The distinction should not be based on a timeline of when certain activities take place, but, rather, on the nature of the activities and the costs. This, however, leads to other questions, such as whether test runs of a new plant are start-up costs or costs to get the fixed asset ready for its intended use. SOP 98-5 says CPAs should look to an entity's policy of accounting for fixed assets. In other words, the SOP is not intended to override level-A GAAP issued by the FASB. What is GAAP for fixed assets? For most entities, the primary level-A GAAP sources for fixed asset accounting include chapter 9, section C, of Accounting Research Bulletin (ARB) no. 43, Depreciation, and FASB Statement no. 34, Capitalization of Interest Cost, which refers to the notion of capitalization up to the point that an asset is ready for its intended me. Neither source provides complete details about what costs are capitalizable. Instead, CPAs often must use textbooks and industry practice to determine detailed fixed asset accounting policies. Intermediate financial accounting textbooks include the following expenditures as fixed assets: (1) the cost of building--materials, labor and overhead incurred during construction; professional fees; and building permits and (2) the cost of purchasing--purchase price, freight and handling; insurance during transit, assembly and installation; and the cost of trial runs. START-UP COSTS VS. INVENTORY COSTS Certain costs an entity incurs in conjunction with start-up activities may relate to the acquisition or manufacture of inventory. A CPA may encounter problems similar to those of fixed assets--how to distinguish between one-time activities that are related to introducing a new product (start-up) and activities related to getting the inventory ready for sale (inventory). …