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What are Incorporation Costs?
Incorporation costs refer to the fees and expenses that are incurred in the process of forming a new legal entity, such as a corporation or limited liability company (LLC). These costs can include a range of expenses, such as legal fees, accounting fees, and other professional fees.
For example, a company may need to pay legal fees to a lawyer to draft and file the Articles of Incorporation, which are the legal documents that outline the basic structure and purpose of the corporation. The company may also need to pay accounting fees to a professional to help with the financial and tax aspects of the incorporation process.
Incorporation costs are typically paid by the shareholder or shareholders who are forming the new legal entity. This could be an individual or a group of individuals, or it could be another legal entity such as a partnership or another corporation. The costs are then typically reimbursed to the shareholder(s) once the new legal entity has come into existence and has obtained its own funds and bank account.
It is important for companies to carefully track and account for their incorporation costs, as these costs can be significant and can have a significant impact on the company’s financial statements.
Examples of Incorporation Costs
- Federal, state, or municipal registration fees: These are fees that are paid to the government to process and file the necessary paperwork to form a corporation. The amount of the fees can vary depending on the jurisdiction in which the corporation is being formed and the type of corporation being formed.
- Legal name registration fees: In some cases, a company may need to register its legal name with the government in order to operate as a corporation. This may involve paying a fee to reserve the name or to register it with the appropriate authorities.
- Legal fees to prepare Articles of Incorporation: A company may need to hire an attorney to help prepare the Articles of Incorporation, which are the legal documents that outline the basic structure and purpose of the corporation. This can involve significant legal fees, depending on the complexity of the company’s business and the legal issues involved.
- Professional fees for consultation on legal and tax structuring: A company may need to consult with legal and tax professionals to ensure that its incorporation is structured in the most advantageous way for the company and its shareholders. This can involve paying professional fees for this consultation.
- Research and development costs associated with incorporating the legal entity: A company may incur costs related to researching and developing the legal structure and business plan for the corporation. This could include costs associated with market research, business planning, and other activities related to the incorporation process.
- Legal fees to prepare shareholder agreements: A company may need to hire an attorney to prepare shareholder agreements, which outline the rights and responsibilities of the shareholders in the corporation. This can involve significant legal fees, depending on the complexity of the agreements and the legal issues involved.
- Legal fees to transfer assets into the newly incorporated legal entity: A company may need to hire an attorney to help transfer assets, such as property or equipment, into the newly incorporated legal entity. This can involve significant legal fees, depending on the complexity of the transfer and the legal issues involved.
Journal Entries for Incorporation Costs
There are two main ways that a company may choose to account for its incorporation costs:
- Expensing: This involves recording the incorporation costs as an expense in the year that they are incurred. This means that the costs are recognized as a reduction in the company’s profits for that year.
- Capitalization and amortization: This involves recording the incorporation costs as an asset on the company’s balance sheet and then recognizing the costs as an expense over a period of time, typically through a process called amortization. Amortization is the systematic allocation of the cost of an intangible asset over its useful life. This means that the company recognizes a portion of the incorporation costs as an expense each year, rather than all at once.
The decision of whether to expense or capitalize incorporation costs can depend on a number of factors, such as the nature of the costs, the company’s accounting policies, and the relevant accounting standards.
Journal entry for expensing incorporation costs
Tony Stark has paid $50,000 to a law firm to incorporate Stark Industries Inc., this included filing Articles of Incorporation and establishing Tony Stark as the 100% common shareholder. Stark Industries Inc.’s accountant has advised that the incorporation costs are to be expensed for accounting purposes.
| Account | ||
|---|---|---|
| Incorporation costs (expense) | $50,000 | |
| Due to/from shareholder | $50,000 |
Journal entries for capitalizing incorporation costs
Tony Stark has paid $50,000 to a law firm to incorporate Stark Industries Inc., this included filing Articles of Incorporation and establishing Tony Stark as the 100% common shareholder. Stark Industries Inc.’s accountant has advised that the incorporation costs are to be capitalized for accounting purposes, and be amortized over 5 years.
| Account | ||
|---|---|---|
| Incorporation costs (asset) | $50,000 | |
| Due to/from shareholder | $50,000 |
After Year 1, Stark Industries Inc. must record the amortization of the incorporation costs.
| Account | ||
|---|---|---|
| Amortization expense | $10,000 | |
| Accumulated amortization – incorporation costs | $10,000 |
