Legal Cost of Formation

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How should a company account for the legal costs of formation? Should the accounting treatment be the same as that for underwritten and other share issue costs?

Generally it is recorded as the asset but as it does not have any economic future benefits to the company and it occurs only once so it should be treated as intangible assets. Under paragraph 69 of AASB 138, intangible assets does not allow the initial cost to be treated as an asset which needs to be treated as an expense and should be written off immediately as an expense. Underwriting and other issue costs are treated as a contra to the share capital account and hence are deducted from share capital in determining the amount of equity raised from the share issue. If share issue costs are recorded in a separate account, the balance of the account must be deducted, as a contra account, from share capital. The treatment of underwriting and other costs of issuing equity instruments as a reduction of the equity amount raised applies also if certain types of debentures, e.g. convertible notes are classified as equity. Furthermore, if issues costs have been incurred but the proposed equity issue is ultimately unsuccessful, these issue costs should be treated as an expense in that no contribution by owners has actually occurred. However in the case of preference shares, some are classified in the financial statements as equity and some as liability. Share issue costs on preference shares classified as equity are treated as per the requirements of AASB 132. If share issue costs arise on the preference shares which are classified in the accounting records as a liability, the money raised from the issue is not a contribution by owners; however, the issue costs must still be regarded as a reduction of the amount raised and therefore are deducted from the preference shares liability account.
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