Question

Fern Company is a U.S.-based company that designs and builds compressors for large HVAC units. Fern decides to build a new plant in China, its first attempt at doing business internationally. During its start-up phase, Fern incurs $2,000,000 of start-up costs including $1,000,000 in legal fees, $700,000 to introduce its product, and another $300,000 in state fees to the Chinese government to organize the new business entity. Fern Company's CEO fully expects the company to become profitable during its 3rd year of operations. How should Fern Company account for these costs?

Entry field with correct answer
A. Fern can capitalize $700,000 related to introducing its product, but the other costs must be expensed as incurred.
B. Fern can capitalize $1,000,000 in legal fees, but the other costs must be expensed as incurred.
C. Fern can capitalize $1,300,000 related to legal and state fees, but the other costs must be expensed as incurred.
D. Fern must expense all $2,000,000 start-up costs as incurred.

Answer 1

Fern Company should expense all $2,000,000 of startup costs as they are incurred, in compliance with Generally Accepted Accounting Principles (GAAP) (D).

Step-by-step explanation:

When considering startup costs, accounting principles typically require these costs to be expensed as they are incurred. The initial costs that Fern Company has incurred, including legal fees, product introduction, and entity organization fees, are all considered part of the startup activities.

According to Generally Accepted Accounting Principles (GAAP), startup costs are not capitalizable and must be expensed in the period in which they occur. Therefore, for the accounting of these initial expenses, Fern Company should record them in their income statement as an expense immediately.