This article, "Why Should I Segregate Pre-Opening Costs?," originally appeared on BDO.com.
There are a variety of costs related to opening a new location. Some expenses, such as new kitchen equipment, will be capitalized and depreciated over time. Other expenses, such as store opening team labor costs, will be expensed as incurred. The costs immediately expensed are referred to as start-up costs, organization costs, or pre-opening costs and should be tracked separately from other expenses.
Segregating pre-opening costs has many benefits:
- It will allow you to get an idea of what it costs to open a new location and will provide an excellent benchmark for future expansion.
- Is your EBITDA calculation included as part of your debt covenants? If so, the bank may allow you to add back pre-opening costs back to earnings when calculating EBITDA, as they will not recur in the ordinary course of business.
- The food and beverage costs and labor incurred prior to the store opening will most likely not be comparable to cost of sales and labor incurred when the location is open for business. The segregation will assist with internal analytics and comparisons used to measure performance.
Pre-opening costs can be tracked many ways, but the most efficient method may be to create separate general ledger accounts for these expenses. For example, you probably have accounts that record rent expense for each location. Many landlords give new tenants a free rent period before the location opens, and the straight-line rent expense is recorded as a liability during the free rent period because cash is not being paid. But did you know that this expense is considered a pre-opening expense? Since you will probably only have a free rent period once during the life of the lease, it is beneficial to track the expense during that period separately from other rent expense.
Typical pre-opening costs to track separately are restaurant labor (including payroll taxes and benefits), cost of sales, rent, and opening team labor and travel expenses. These costs should be expensed and classified as pre-opening. Once the store is open, these ongoing expenses will be recorded in their normal expense categories.
It is important to note that the tax law regarding pre-opening costs is slightly different than GAAP. For your tax return, you are required to capitalize pre-opening costs for the first location of a new taxpayer. The capitalized costs should be amortized over 15 years. Any pre-opening costs incurred for other locations opened in the same taxable entity can be expensed as incurred. GAAP, however, requires all pre-opening costs to be expensed, even if you are opening your first location in a new region.
If you are interested in learning about certain costs that can be capitalized during the pre-opening phase, see last week’s blog titled “Interest and Wages during Construction – Capitalize!”