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

It can be difficult to properly categorize and report startup costs accurately. 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 essential expenses associated with the initial stages of a company or branch. 

In general, GAAP startup activities include all of the following:

• Launching a new business 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, registration and legal fees, employee salaries and training, initial advertising or marketing, and intangibles, like patents or product development costs. 

However, any business 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 small business or introduce a new product or service. Tracking your operating expense details 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 and accrual accounting. Even if your company isn't a public corporate entity, complying with those principles is a good accounting 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 Internal Revenue Service (IRS) prescribes certain tax benefits and exemptions for some business startup costs. To maximize your tax deductions, it's essential to accurately account for and document them.

5 tips for accounting for GAAP startup costs

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

1. Identify and classify startup costs

As you begin to generate cash flow and spend money on your organizational costs, keep careful track of them. Store your receipts in a safe location that you can easily access. 

If you have any other documentation related to small business 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.

Separate your fixed costs and variable costs, then classify each according to its type. You can create startup expense categories for common business startup costs and assign them 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 startup organizational cost 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, for a capital expenditure like a new vehicle, you won't expense its entire value at once. 

Instead, you'll depreciate it over its useful life. That depreciation becomes a business cost that reduces your income each period — and your taxable income — until the property fully depreciates.

For SaaS business owners, 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 a business startup cost for intangible assets like copyrights, trademarks, or patents. Similar to property, you'll expense the value of intangible organization 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 take a monthly expense for the prorated value of the intangible over 180 months. 

Start recording recurring expenses for amortization in the month you begin using the intangible for business operations.

4. Track and record startup costs accurately

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

Ensure you maintain receipts, contracts, and any other documentation you have for startup expenses. Your documentation will make validating the organizational 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 accountant or fractional CFO service provider. 

They can help ensure you account for your startup expenses appropriately. With their support, you can also maximize your tax deductions for essential expenses.

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 ongoing expenses 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.