Accounting for GAAP startup costs: 5 tips to get you started

When you're launching a SaaS business, it's important to be ready for initial expenses that set up your operations. These expenses are referred to as startup costs under the Generally Accepted Accounting Principles (GAAP).

Knowing how to account for your startup costs is critical, as they'll impact your financial statements and tax filings. However, it can be difficult to properly categorize and report these costs. As a result, many founders end up facing financial uncertainty, compliance issues, and operational challenges.

In this article, we'll demystify how to account for GAAP startup costs in your general ledger. You'll learn the basics of startup cost accounting and how it impacts your business operations.

What are GAAP startup costs?

GAAP is the foundation of consistent financial reporting, ensuring transparency and accuracy. The Financial Accounting Standards Board (FASB) establishes U.S. GAAP standards, which most private and public companies follow in their accounting practices. International companies outside the U.S. primarily follow IFRS standards.

U.S. GAAP includes a specific definition of startup costs, which businesses use to determine how to account for certain expenses associated with opening a new company or branch. In general, GAAP startup activities include all of the following:

• Launching a new facility or operation
• Operating a business in a new region or territory
• Pursuing a new class of clients
• Introducing brand-new products or services
• Opening an entirely new company

Common startup expenses include deposits, legal and registration fees, employee training, initial advertising or marketing, and intangibles, like patents or product development costs. However, any expense can potentially qualify as a startup cost, as long as it relates to startup business activity.

Business expenses relating to pre-existing operations, products, or services generally don't meet the definition of startup costs.

The significance of accurate accounting for startup costs

Accurately accounting for startup costs is critical for several reasons:

• Informed decision-making: You'll need to make many important decisions as you start a business or introduce a new product or service. Tracking your operating expenses helps you keep your budget in line and prevents costly decisions that could impact the financial health of your business.
• Regulatory compliance: Public companies must undergo financial audits and reviews, which require adherence to U.S. GAAP. Even if your company isn't a public corporate entity, complying with GAAP principles is good practice.
• Business valuation: At some point, you may want to sell your company, obtain debt financing, or attract potential investors. Startup costs are part of your business valuation, so they'll be a factor in any sales, credit, or investment activity.
• Tax adherence: The IRS prescribes certain tax benefits and exemptions for some startup costs. To get the maximum deduction, it's essential to accurately account for and document them.

5 Tips for accounting for GAAP startup costs

Accounting for GAAP startup costs probably sounds a little intimidating. However, it doesn't have to be! Follow these five tips to streamline the process.

1. Identify and classify startup costs

As you spend money on your organizational costs, carefully track all your costs. Store your receipts in a safe location that you can easily access. If you have any other documentation related to startup costs, such as emails, sales contracts, or purchase orders, keep those, too. You may need it if you undergo a financial review or tax audit.

Classify each type of business cost you incur according to its type. You can create expense categories and assign your costs appropriately. For instance, registering and licensing a business will fall under your legal and administrative costs. Startup marketing expenses include setting up a website and designing your company logo.

2. Capitalize vs. Expense: know the difference

Startup costs are either expensed or capitalized. You'll deduct the entirety of an expensed charge during the period it's incurred. However, deductions for capitalized expenses occur over time, ranging up to 15 years or longer.

You'll capitalize property costs that have an expected useful life longer than three years. For instance, if you buy a capital asset like a new vehicle, you won't expense its entire value at once. Instead, you'll determine its useful life and depreciate it over time. The depreciation will reduce your income for each period — and reduce your taxable income — until the property fully depreciates.

For SaaS businesses, capitalizing software development costs is another consideration. Any software development efforts that add long-term value may also be capitalized and amortized over time.

You may also have startup costs for intangible assets like copyrights, trademarks, or patents. Similar to property, you'll expense the value of intangible costs over a set time period. While expensing costs over time for tangible assets is called depreciation, doing so for intangible assets is known as amortization.

3. Establish the amortization period

You'll depreciate or amortize capitalized expenses once you place the property in service or use it to generate income. Amortization and depreciation end once the asset reaches the end of its useful life.

Tangible property, like buildings, vehicles, and computer equipment, typically follows the Modified Accelerated Cost Recovery System (MACRS) schedule for depreciation. Periods under MACRS vary from three to 27.5 years. Vehicles and computer equipment have a five-year depreciation period, while office furniture depreciates over seven years. The longest depreciation period of 27.5 years applies to office buildings.

The IRS classifies most intangibles as Section 197 property. Intangibles follow a 15-year amortization schedule, requiring you to amortize the value of the intangible each month over 180 months. Depreciation begins in the month you start using the intangible for business operations.

4. Track and record startup costs accurately

As you accumulate startup costs for your organization, ensure you properly account for them in your accounting system. Determine their tax basis, which is their initial price or value to the organization. You'll also want to classify them as expenses or capitalized items.

Ensure you maintain receipts, contracts, and any other documentation you have for startup expenses. Your documentation will make validating the costs during an audit or on your tax return much more straightforward.

5. Seek professional guidance and stay updated

The complexity of startup costs can vary tremendously. A solopreneur with a service operating business will likely have far fewer (and less intricate) startup costs than a SaaS company with intangible assets and research and development costs.

If you find yourself overwhelmed by startup costs and classifications, don't try to handle them yourself. Instead, seek professional guidance from a tax professional or fractional CFO service provider. They can help ensure you account for your startup expenses appropriately. With their support, you can also maximize your deductible expenses and business deductions.

Future-proof your startup's financials with GAAP assistance

Getting your business on solid financial footing starts with accurate startup cost accounting. You'll want to ensure you properly classify startup costs, whether they're one-time expenses or capitalized ones. It's also important to keep documentation of all the costs you incur. That way, you can validate them during a financial review or audit.

If GAAP accounting and IRS rules seem mind-boggling, AI-driven accounting software can help you record your startup costs and financial experts can ensure you're on the right track.