Expenses borne by the promoter from his personal account

What to do with expenses incurred by founder on behalf of the company from personal account Incorporating a company is a huge task. Promoters of company make great Expenses borne by the promoter from his personal accountefforts so that the company comes into existence and gets incorporated. While incorporating there are expenses which the promoter borne from his personal account which he gets reimbursed when the company owns an operative account of its own after incorporation. This article is basically based on what happens to the expenses borne by the promoter from his personal account. What are preliminary expenses? These are incurred for the incorporation of a company. They may be paid by the promoters before the company is incorporated or by the company after it is incorporated. And they include the following: a) professional charges paid for drafting of memorandum of association and articles of association; b) professional charges for consultation in incorporating the company; c) cost of printing of the initial copies of MoA and AoA; d) stamp duty for the documents; e) registration fee paid to the Registrar of Companies (RoC) for incorporation; f) bank charges incurred on the above; and g) incidental expenses such as stationary, conveyance, and so on. Are share issue expenses preliminary expenses? Preliminary expenses are those incurred in connection with the incorporation of the company. Shares are issued after the company is incorporated. Share issue expenses are not a part of preliminary expenses. Therefore, it is a wrong to disclose share issue expense as part of preliminary expenses. No accounting entry would be permissible under the head preliminary expenses once the company is incorporated.   How to record share issue expenses? These are to be recorded under a separate head of account. Section 78 of the Companies Act, dealing with utilization of securities premium, states defraying of preliminary expense under a clause different from the clause defraying expenditure incurred on issue of shares and/or debentures. It also indicates that share issue expenses are different from preliminary expenses.   Accounting treatment of preliminary expenses: Preliminary expenses are capitalized and amortized over a reasonable period of time. Format of balance-sheet of a company provides for disclosure of un-amortized preliminary expenses. Recognizing preliminary expenses: Since the expenditure is incurred and paid by the promoters even before the company is incorporated, there is normally a clause that the promoters are reimbursed of all the expenditure. It would not be proper to treat these expenses as accrued as on the date of incorporation of the company and to show them as outstanding expenditure. There cannot be any transactions entered into by the company before it is incorporated. Accounting Standard on preliminary expenses: AS 26 dealing with intangible assets covers preliminary expenses as well. The period over which these preliminary expenses are to be amortized is best left to the judgment of the directors of the company. AS 26 suggests writing off intangible assets over a period of 10 years, though a different period is permissible if it is justified in the opinion of the management. It is a common practice to write off these preliminary expenses in a period of five years, though there is no legal provision to this effect. A company can as well write off its preliminary expenses in the same year as it incurs. Preliminary expenses in other forms of organization: Setting up other forms of organization, such as partnership firms, does not involve much expenditure. Perhaps, for this reason, there is no provision of preliminary expenses under the Partnership Act Audit of preliminary expenses: Audit of a company in the first year of its incorporation involves audit of preliminary expenses. Over the next few years, the only matter to be concerned with is write off of preliminary expenses. At the planning stage, the auditor should enquire of the company about the details of preliminary expenses. Reference to the minutes of the first meeting of board of directors indicates the quantum of preliminary expenses and the period over which it is proposed to be written off. The auditor would do well to retain a copy of the minutes for his documentation. It is common practice that the chartered accountant associated with the incorporation of a company is appointed as first auditor of the company; this is not essential, though. Incorporation of a company can as well be made with the help of other professionals such as company secretaries, advocates, and so on. During the course of audit, the auditor should vouch the expenditure with reference to the bills and vouchers of expenditure. There would be certain expenses, such as stamp duty affixed on the memorandum and articles of association, which is filed with the Registrar for incorporation. Therefore, the audit evidence in support of stamp duty paid is less conclusive. Under these circumstances, the auditor can verify the receipt issued by the Registrar of Stamps for stamps issued by him. Additionally, he may require the company to produce a photocopy of the memorandum and articles of association, duly attested by a director of the company. Audit of preliminary expenses is a peculiar situation since these are incurred even before the company is incorporated. The auditor should read the memorandum and articles of Association to see if the clause of reimbursing the preliminary expenditure is contained therein. Possibly, preliminary expenditure could have been incurred by more than one person. Each one of the promoters who incurs the expenditure in connection with the incorporation of the company has to produce a statement of expenditure to seek reimbursement. Such a statement should be supported by the details of expenditure and the relevant bills and receipts. The minutes of the board of directors would be helpful to quantify the expenditure. The board should adopt the preliminary expenditure and also decide the period over which it has to be written off. Another area of concern to the auditor would be the mode of reimbursement of preliminary expenditure. It can be by way of reimbursement in cash or allotment of shares. If shares are allotted through reimbursement of preliminary expenditure, it amounts to allotment of shares in consideration other than cash, and the disclosure norms as per Schedule VI would apply. Section 227(1A) requires an auditor to satisfy that transactions represented merely by way of book entries are not prejudicial to the interests of the company and its shareholders. Write-off of preliminary expenditure being one such, the auditor should use his diligence to satisfy him about both the quantum of preliminary expenditure as well as the period over which it is to be written off. Preliminary expenses under the Income-Tax Act: The I-T Act provides for amortization of preliminary expenses. Section 35 D specifies the expenditure to be included in preliminary expenditure, which under the I-T Act is allowable for all types of assesses. Conceptually, this is different from preliminary expenses under company law. Allowability of share issue expenses under the I-T Act: Share issue expenses are not normally allowable as business expenditure. The only possibility of claiming share issue expenses under the I-T Act is provided in Section 35 D. Preliminary expenses under this section covers expenditure incurred for raising funds for the project. As a result, if shares are issued to fund the project, such expenditure can be included under preliminary expenses and claimed for amortization under Section 35 D. Thanks for reading for this article. Please feel free to write to us, We want to hear it all!Suggestions? Complaints? Feedback? Requests?  at [info@taxmantra.com] or call us at +91 88208208 11. We would be more than happy to assist you.