In simple words, all the expenses that are incidental to the incorporation or commencement of a business are known as preliminary expenses. For example, statutory fees, stamp duty, registration fees, etc.
Treatment in Financial Statements
In case the value of preliminary expenses is less we write off the same at once however, they are shown as an intangible asset in the balance sheet and written off at regular intervals over a fiscal period when the value of the expenses is high. I would like to explain this concept further with the help of an example.
ABC Ltd. incurs an expense of 4,00,00 before the commencement of its business. They decide to write off the preliminary expense of 4,00,000 within the next 4 financial years. The journal entries in the books of ABC Ltd. are as follows:
|Preliminary expenses a/c||Debit||4,00,000||Debit the increase in asset|
|To Bank a/c||Credit||4,00,000||Credit the decrease in asset|
(being expenses paid)
|Preliminary expenses are written off a/c||Debit||1,00,000||Debit the increase in expenses|
|To Preliminary expenses a/c||Credit||1,00,000||Credit the decrease in asset|
(being expenses written off)
Note: As the company has decided to write off the preliminary expenses within the next 4 financial years, therefore only 1/4th of the amount (4,00,000 x 1/4 = 1,00,000) will be recorded in the current year’s income statement and the remaining balance of (3,00,000) shall be recorded in the balance sheet of the same financial period.
|Profit and Loss a/c||Debit||1,00,000||Debit the increase in expenses|
|To Preliminary expenses a/c||Credit||1,00,000||Credit the decrease in expenses|
(being expenses transferred to p&l a/c)