 Hello and welcome to the session in which we will discuss organizational expenditure and startup costs. Two different topics, very similar, but we're going to break them into two separate components. So what about organizational expenditure? What did we learn about this topic before? Well, organizational expenditure we learned about this topic in-gap. And what is organizational expenditure? It's when the company is forming. When the company is forming, there are legal costs, there are consulting costs, there are accounting costs. And as a result, those costs we need to be accounted for. Hello and welcome to the session in which we will discuss organizational expenditure and startup costs. Well, we did learn about organizational expenditure for gap. And what is the idea of organizational expenditure? Well, the overall idea is the same. Before a company is formed legally, before a corporation is incorporated, well, you are going to incur certain costs, legal costs, consulting costs, costs to put the legal paper together for the company to start. Now, from a gap perspective, from a financial accounting perspective, what do we do with those costs? Well, we assume those costs will have no future economic benefits. From a gap perspective, we will expense them, whatever we do, we will expense them, and we credit cash. And we're going to have organizational costs for an organizational expense debit, and we credit cash. Now, we need to learn from a tax perspective, what are our options? And since gap will be treated differently than IRS, then we're going to have a difference which we'll have to account for on schedule M1. Notice in these sessions, every time there's a difference between gap versus IRS or gap versus tax, I always mention eventually we're going to have to reconcile all these items on schedule M1. So let's go back and dive into organizational expenses. What did they include? Well, as I mentioned, legal services connected to the establishment of the organization. An example of it will be drafting the corporate charters and bylaws. Well, you may need a lawyer or hire a firm to do that for you. Essential accounting services before the organization comes to life. Cost associated with temporary directors and meetings held for the organizational purposes by directors and shareholders, you're going to be incurring cost in those meetings. Well, also that's organizational cost. Fees paid to the state where the corporation is incorporated, you're going to have to pay a fee. It's not that much, $300 or $600 for the state of Delaware or whatever state you are, you are incorporating in. Well, that's also considered organizational cost. So those are typical example of organizational cost. We're going to see what startup cost later. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat accounting lectures is a supplemental educational tool that's going to help you with your CPA exam preparation, as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Myles. My accounting courses are aligned with your accounting courses, broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions, as well as exercises. Go ahead, start your free trial today. So when the corporation initiates its operation, it means when they start their business, they have the option, notice, it's an election to amortize organizational expense over a period of 150 months commencing from the month the business begins. So simply put, from the time you start your operation, you're going to be incurring some cost. What you do once you start your business, you are going to amortize this expense. What is amortization? It means treated as an asset, treated as an asset, then expense it, amortize it as an intangible asset over 180 months. Well, is that all? No, there's a special provision that allowed the immediate expensing of the first $5,000 of these expenses. So guess what? Well, they will tell you the general rule is treat those as an asset for tax purposes. You treat them as an asset and you amortize them. That's the general rule. Now for GAAP, you'd say expense them, right? And I hope this makes sense because IRS, IRS here, they're basically, they don't want you to take the expense because if you take the expense, you're going to lower your taxable income. Does that make sense? That's why they don't want you to do that. However, there is a special provision where you can expense immediately $5,000. However, not everyone can expense this $5,000. You could expense that $5,000 and you will start to lose that $5,000 of immediate expenses, dollar to dollar. Once your organizational expense exceeds $50,000. Simply put, if you have $40,000 of organizational expense, no worries, you'll get your $5,000. If you have $48,000 of organizational expense, you'll get the $5,000 immediate expensing, then you can amortize the rest. If you have $51,000 of organizational expense, guess what? Of that $5,000, now you lost $1,000 of immediate expensing. What's left is $4,000. So you can immediately expense $4,000. If you have organizational expense of $55,000, well, if that's the case, you lost $5,000. You lost the whole $5,000 that you can use because you're already at $5,000 above $50,000. So the limit starts at $50,000. The limit starts at $50,000. So that's what you need to know. Don't worry. We're going to work examples illustrating this concept, but that's basically the special provision. So they do allow you to expense $5,000 as long as you don't have too much of organizational expense. What's too much? Too much starts at $50,000 and too much, way, way too much, $55,000. You no longer, you can no longer take a penny of immediate expense and you can still amortize. Now, we have to know that expenditure relating to issuance and sales of shares or other securities. Now, notice the difference here. Those are costs related to the stock itself, to issue the stock, as well as the transfer of asset to a corporation. Any costs related to that are not eligible for the qualification. These, in quote, expenses because they're not expenses, diminishes the amount of capital raised and are not deductible in any way. Hold on a second. If they're not deductible, if they're not expenses, if they're not asset, if I cannot amortize them, what do I do with those expenses? Expenses such as those, what we do is we debit, paid in capital and we credit whatever we do, credit cash. So what they do is they reduce your paid in capital account, your equity account. So they're not expense, kind of they reduce your equity. Let's illustrate the organizational expenditure. Let's assume Farhad Corporation, the C Corporation operating on a calendar year basis, and we're going to see why it's important to mention the year commenced operation on September 1st of the present year and accumulated 53,000 in organizational expense. What's special about 53,000? Well, 53,000 is 3,000 above too much organizational expense. Remember, you could immediately expense five. Guess what? I already lost of that five, 3,000. All what I can do is if I want to, if I want to maximize my expenses, I can expense two. And let's assume Farhad's objective is to, is to maximize the expenses and amortize anything that's left. Well, here's what's going to happen. If I can do that, if I want to do that, I can only take immediate expensing of 2,000 because I am 3,000 above 50,000. Well, 3,000 above 50,000, that additional 3,000 above 50, made me lose 3,000 of my immediate expense. So I'm left with two. So if I'm left with two, I have 51,000 left. The remaining 51,000, I can amortize it over 180 month, whatever that amount is, if I take 51,000 divided by 180 month, my monthly amortization is $283 and I'm have four month for that year, which is September, October, November, and December. And that's going to give me, if my math is right, $1,133 in some change. So my total expensing for that year is $3,133, the immediate $2,000 of expenses plus the amount that I amortize for the remaining. Let's take a look at another example. Farhad Corporation was formed and started, started business October 1st. Remember, you can start the amortization only when you start the business. Farhad incurred the following expenditure from October to December. Fees paid to the state in order to incorporate $2,000, cost to print and sell stock certificate $15,000, quite an expensive deal, accrued legal services for drafting the corporate charter $21,000, notice those are accrued not paid, expenditure incurred for temporary director $23,000. So the first thing is here I have it accrued to mention it's not cash. Well, if it's not cash, can I still, if I'm a cash basis taxpayer and I accrue those expenses, can I still count them? And the answer is yes, whether you paid them in cash or accrued, you could still expense them. Now, however, how many of these expenses are considered organizational expense is fee is fee paid to the state and organizational expense in order to incorporate. Yes, cost to print and sell stock certificate. No, remember what I told you about that money? If you incur any money related to the issuance of stock, which is cost to print and sell the stock certificate, you reduce your paid in capital. Legal services, sure they are whether accrued or paid in cash, that's organizational expense and expenditure incurred for temporary directors before the organizational start $23,000. That's also organizational expense. If we add them all up, they will add up to $46,000. Guess what? We are in good shape. In what sense? If we want to maximize our expenses, you don't have to. But if you want to, you could immediately expense $5,000. What's left is $41,000. $41,000, which is $46,000 because I immediately expense $5,000 out of the 46. What's left is 41. And if I take this 41 and I divided by 180, I'm going to be able to expense $227.77 per month. And I have three months from October, October, November and December. If I multiply this by three, I'm going to get $683. Therefore, if I want to maximize my expense, it's going to be $5,683 for that year, which is 2024. Let's assume the legal expenses, the legal accrued expenses were $30,000. So what I'm trying to say is, let's instead of $20,000, I incur $30,000. Well, let's see. If I take $2,000 plus, let's make it $29,000. That's rather than $30,000. Let's make it $29,000 plus $29,000 plus $23,000. Now my accrued expenses, let's make sure the math is right, $231,000, $54,000. That's correct, $54,000. What happens now? Well, if my organizational expense were $54,000, now I can only immediately expense $1,000. So if I'm going to have $54,000, I'm only going to expense $1,000 immediately. What's left is $53,000. I divide this by $180,000. Whatever that monthly cost is multiplied by $3,000. It will be $1,000 plus this answer. What if my accrued legal expenses were $35,000 now? Well, if my accrued legal expenses were $35,000, let me add them up. If I add $35,000 plus $23,000 plus $2,000, well, I'm going to be over $55,000. So $35,000 plus $23,000 plus $23,000, that's $58,000. Just those two will put me over $55,000 plus the two is $60,000. So what happens is I'm going to take all the amounts, the $2,000 plus the $35,000 plus the $23,000 and amortize them. That's all what I can do and deduct $3,000 in 2024. Now, organizational planning, organizational expenditure, I would involve some proper tax planning. Why? Because in order to be eligible for the election to take that immediate expensing, the expenditure must be accrued prior to the conclusion of the tax year in which the corporation starts its operation. Simply put, it's the year when you start your operation. So the corporation choosing accounting method, as I mentioned, is irrelevant, whether it's cash or accrual. Even if it's a cash basis, as we saw earlier, and you incur the expense, but you don't pay it until the subsequent year, it's still qualified as just we saw earlier when it comes to the accrued legal services. However, it's important to note that this rule could present a potential pitfall for corporation formed later in their initial taxable year. What does that mean? It means sometime what's going to happen is this. You might be incurring organizational cost. Let's assume this is year one and this is year two. And the organizational cost, some of it may fall in year one, some of it may fall in year two. Now, what happens is your organizational cost is split. So if you do proper planning, you might be able maybe it's much better to combine those two, or maybe keep them split or move the expense from year one to year two or move the expense from year two to year one. Okay, so let's take a look at an example to see how this work if that happens. Let's assume Farhat Corporation is established December 29 at a incur qualified organizational expense as follows 60,000 in year 2024 and year one and 25,000 in the following year. So notice in the two years, 60 plus 25, they incur a cost of 85,000. Now assuming Farhat follows the calendar year for tax purposes, what would happen? Well, it can only deduct 60,000 of the organizational expenditure over 180 month period. Why? Because you can only do that because the 60,000 fell in the first year. Whatever you incur in the next year, you already started your operation. Okay, so you are established and incurred those expenses in the year that you started so that 25,000 cannot be combined. So tax planning, what would you do? The first option if you're into tax planning is to ensure all the expenditure incurred in December. So try to make those 25,000 spend them in December of 2024. So the entire amount now can be amortized over 180 month period. The second option is to do what? The second option since the remaining 25,000 incur in January, what I would do, I will start my year. I will rather than choose a calendar year starting January 1. I will start a physical year after January 31. And this way I will be able to include those because now they are considered in the same year. And this way I can amortize the full amount of 85,000. What about startup expenditure? Because this lesson is about organizational expenditure as well as startup expenditure. How do we treat startup expenditure when it comes to taxes? Well, guess what? They are similar in form of tax, in terms of tax handling. However, they should not be confused with organizational expenditure. Startup expenditure include a range of investigation costs associated with entering a new business. So when you enter a new business, you're going to study the market. You're going to have to travel. You're going to have to look at financial statements. You're going to have to audit financial statement. Maybe if you're buying a company, you're going to incur legal fees. But that's in the process of investigating the business. All these costs are called startup costs, which are different than organizational expenditure where you already know you have the corporation and you are basically putting the business together from a legal perspective. Here you're investigating whether the business, whether you should go into this business or not. They also include operating costs like rent, payroll that are incurred by the corporation before generating any gross profit. Sometimes you might need employees to help you in this process. You might have to, for example, if you're traveling to South America to start the business, you may incur an office rent. All this process is to investigate whether you want to go into this business or not. Now, generally speaking, startup expenditure are required to be capitalized. Simply put, they are treated the same as organizational expenditure. Taxpayers have the option to elect to deduct startup expenditure in the same manner as organizational expenditure. Under this election, again, 5,000 of startup costs can be immediately expensed. Again, subject to phase out limit. Any remaining will be amortized over 180 months. Again, the rules governing the election and waiver of the election for organizational expenditure applies also to startup expenditure. So now it's a different type of expenditure, but the same rules apply. What should you do now? Well, organizational expenditure, startup expenditure, why are they important? Because the way they are treated for GAP is different the way they are treated for IRS. That's important and we need to know the rules. Go to far hat lectures, look at additional lectures, MCQs, true, false, additional notes. That's going to help you because this is basically we're setting the ground, we're setting the seed to work on schedule M1. Good luck, study hard, and of course, stay safe.