Preliminary expenses treatment

This query is : Resolved

yashsr (Querist)
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29 March 2012 Hello,

A company was formed in May 2009 and Preliminary Expenses of Rs.13000 was incurred. Share Capital of the Private Limited Company is Rs.1 lac.

The accounts for Financial Year 09-10 were audited by an auditor say named ABC. Preliminary Expenses in that year were not written off both in accounts as also in the Income Tax Return. Now, a new auditor XYZ is appointed for Financial Year 10-11 and its books haven't been audited till date.

What should the new auditor do regarding treatment of Preliminary Expenses? Should he advise the management to write them off completely or just 1/5th?

If completely, what of the following will be the effect in P/L as far as Income tax Return is concerned:
1) 1/5th of 13000 i.e. 2600 will be shown as expense u/s 35D
2) Entire 13000 will be allowed u/s 35D
3) The limit of 13000 is upto 5% of capital employed or 5% of cost of project. Assuming cost of project is negligible, 5% of Capital employed is 5% of 1 lac i.e 5000. So only 1/5th of the same i.e. 1000 will be allowed as expense u/s 35D

Also, is there any chance that the Preliminary Expenses are just carried forward for another year?

yashsr

yashsr (Querist)
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30 March 2012 any ideas experts?

Aashok Kumar Sharma

Aashok Kumar Sharma (Expert)
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10 August 2024 In handling preliminary expenses for the financial years in question, the new auditor XYZ will need to follow both accounting standards and the provisions of the Income Tax Act. Here’s a detailed approach:

### **1. Accounting Treatment**

#### **Accounting Standards (AS 26)**

- **Preliminary Expenses:** According to **AS 26**, preliminary expenses should be fully written off in the year they are incurred. They cannot be amortized or carried forward as an asset on the balance sheet. Therefore, the new auditor XYZ should advise the management to write off the entire preliminary expense of Rs. 13,000 in the Profit & Loss Account of the financial year 2009-10, where it was initially incurred.

- **Adjustment:** If the preliminary expenses were not written off in the earlier audited accounts, the new auditor should ensure that the preliminary expenses are corrected in the financial statements for the current year. The adjustment will involve writing off the entire Rs. 13,000 as an expense in the Profit & Loss Account.

### **2. Income Tax Treatment**

#### **Section 35D of the Income Tax Act**

- **Amortization:** Under Section 35D, a company can amortize preliminary expenses over a period of five years. This section allows for amortization of preliminary expenses as follows:

- **1/5th of Preliminary Expenses:** The company can claim amortization of 1/5th of the preliminary expenses each year for five years. Therefore, if Rs. 13,000 was incurred as preliminary expenses, the company can claim Rs. 2,600 (i.e., Rs. 13,000 / 5) as an expense under Section 35D in the Income Tax Return for each year.

- **Limits and Conditions:** The limit for preliminary expenses under Section 35D is:
- **5% of Capital Employed or Cost of Project:** In your case, with a share capital of Rs. 1 lakh, 5% of the capital is Rs. 5,000. However, since the preliminary expense of Rs. 13,000 exceeds this amount, only up to Rs. 5,000 can be claimed under Section 35D, provided the entire amount was incurred for the purpose of the business.

### **3. Practical Steps for New Auditor XYZ**

1. **Advise on Write-Off:** The new auditor should advise the management to write off the entire preliminary expense of Rs. 13,000 in the Profit & Loss Account for the financial year 2009-10. This adjustment is necessary to comply with AS 26 and to correct the financial statements.

2. **Income Tax Return Adjustment:** For the Income Tax Return:
- **Claim Amortization:** The company should claim amortization of Rs. 2,600 per year (1/5th of Rs. 13,000) under Section 35D for each of the five years.
- **Limit Application:** Ensure that the amount claimed does not exceed the permissible limits. For preliminary expenses exceeding the 5% limit of capital employed, only Rs. 5,000 can be claimed under Section 35D, and the excess may need to be adjusted or written off.

3. **Correcting Past Returns:** If the preliminary expenses were not written off in the previous financial year, the auditor should ensure the correct treatment in the current financial year and may need to file revised returns for past years if necessary.

4. **Carrying Forward:** Preliminary expenses cannot be carried forward as assets under AS 26. They must be written off in the year incurred. However, for tax purposes, amortization can be claimed annually over five years.

### **Summary**

- **Accounting:** Preliminary expenses should be fully written off in the Profit & Loss Account in the year they are incurred.
- **Income Tax:** Claim amortization of up to 1/5th of the preliminary expenses per year under Section 35D, subject to the limits of 5% of capital employed or cost of project.
- **Correction:** Adjust the financial statements and tax returns to reflect the proper treatment of preliminary expenses as per accounting standards and tax regulations.

By following these guidelines, you will ensure compliance with accounting standards and tax laws.

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