Accounting for Transaction Costs: Balancing Capitalization and Expense Recognition

Transaction costs don’t always make headlines, but they can move the numbers in ways that matter. Buying a new asset, restructuring debt, or chasing a merger? The way you account for those costs, either capitalizing or expensing them, shapes your financials and, yes, your compliance story too.

In this blog, we’ll break down what counts as a transaction cost, when it belongs on the balance sheet versus the income statement, and why those decisions carry more weight than most businesses realize.

Table of Contents:

• What Are Transaction Costs?

• Capitalization vs. Expense Recognition

• GAAP and IFRS: Standards and Compliance

• How It Impacts Financial Statements

• Managing Transaction Costs Effectively
  

• Final Thoughts
  
  
• FAQ
  
  

What Are Transaction Costs?

Before we get into the “capitalize or expense” conversation, let’s start with the basics: what exactly are transaction costs?

Some common transaction cost examples include:

• Legal and due diligence fees for mergers and acquisitions
  
  
• Underwriting and advisory fees in issuing securities
  
  
• Appraisal and inspection fees when purchasing real estate or equipment
  
  
• Loan origination fees and banker commissions
  
  

Getting these numbers right matters for several reasons:

• Financial accuracy: Misclassifying transaction costs can overstate or understate expenses or asset values.
  
  
• Tax impact: Capitalized costs may be depreciated or amortized, while expensed items immediately impact taxable income.
  
  
• Regulatory compliance: GAAP and IFRS each have specific rules regarding capitalization and disclosure.
  
  

In short, transaction cost accounting is a strategic component of financial reporting.

Capitalization vs. Expense Recognition: Key Differences

Transaction costs might not get much attention—but how you account for them can shift the way your business looks on paper. Whether you're buying assets, raising capital, or working through a deal, the key question is: capitalize the cost, or expense it?

This choice impacts your financial statements, tax treatment, and how profitable your business appears to the outside world.

In simple terms:

• Capitalizing a cost means you’re adding it to the balance sheet and spreading it out over time.
  
  
•  Expensing it means you’re taking the hit now, all at once, on the income statement.

When to Capitalize:

You should capitalize a transaction cost when it meets specific criteria:

• Directly tied to acquiring or producing a long-term asset: If the cost is necessary to bring the asset into the condition and location needed for use (or sale), it typically qualifies for capitalization.
  
  
• Linked to securing financing or executing a transaction with long-term value: When the transaction will create future economic benefits—like securing funding or acquiring a revenue-generating asset—the related costs are often capitalized.

Common examples of capitalized costs include:

• Legal fees for drafting asset purchase agreements
  
  
• Underwriting and issuance fees when issuing bonds or other securities
  
  
• Commission payments made during property acquisition
  
  

These costs are seen as part of the total investment in the asset or transaction, not just short-term business expenses.

When to Expense:

Costs should be expensed when they don't meet the capitalization criteria—typically when:

• They’re not directly attributable to a specific asset or transaction. General administrative or exploratory work, even if related to a future investment, doesn’t qualify.
  
  
• The deal falls through. If a proposed acquisition or financing doesn’t go ahead, any costs incurred must be expensed.
  
  
• They’re internal or routine. Salaries of employees working on due diligence, for example, are not capitalizable unless they’re performing work directly related to constructing or producing an asset.
  
  

Common examples of expensed costs include:

• General overhead during deal evaluation
  
  
• Salaries and benefits for internal staff supporting M&A activity
  
  
• Legal and consulting fees from a terminated or failed transaction
  
  

These costs are treated as operating expenses, hitting the income statement in the period they’re incurred.

GAAP and IFRS: Standards and Compliance

When it comes to transaction costs, the rules aren’t one-size-fits-all. Businesses need to follow the accounting framework that applies to them—and that framework shapes how those costs show up on the books.

While U.S. GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards) overlap in some areas, they take different approaches to classification and treatment.

Understanding how each framework treats transaction costs is critical for accurate financial reporting—especially for companies operating globally or preparing for audits.

Under GAAP (U.S. Generally Accepted Accounting Principles)

GAAP tends to offer more rule-based, detailed guidance depending on the type of transaction. Different types of costs fall under specific Accounting Standards Codifications (ASCs), each with its own treatment.

Here are a few common examples:

• ASC 805 – Business Combinations
  Most acquisition-related costs—such as legal fees, due diligence, and advisory services—must be expensed as incurred. However, fees directly related to issuing debt or equity as part of the transaction may be capitalized.
  
  
• ASC 310 – Loan Origination
  Certain direct loan origination costs, such as underwriting or application fees, can be capitalized and then amortized over the life of the loan. This aligns the cost recognition with the revenue generated from the loan.
  
  
• ASC 360 – Property, Plant, and Equipment
  Costs that are necessary to acquire, transport, and prepare an asset for use—like installation, site prep, or testing—are capitalized. Indirect costs or post-acquisition repairs, however, are expensed.
  
  

Overall, GAAP aims to align cost treatment with the nature and timing of the benefit the company receives, but it often spells out specific treatment for each case.

Under IFRS (International Financial Reporting Standards)

IFRS takes a principles-based approach. Instead of prescribing detailed rules, it emphasizes broader concepts like future economic benefit and direct attribution. The result? More room for judgment—and more need for consistency.

Here’s how IFRS typically treats transaction costs across key standards:

• IFRS 3 – Business Combinations
  Like GAAP, most acquisition-related transaction costs—including legal, advisory, and professional services—are expensed as incurred. However, costs tied to issuing equity or debt instruments in the transaction can be capitalized.
  
  
• IFRS 9 – Financial Instruments
  Transaction costs that are directly attributable to acquiring or issuing a financial instrument (like a bond or loan) are included in the instrument’s initial measurement. This spreads the cost over the life of the asset or liability.
  
  
• IAS 16 – Property, Plant and Equipment
  Costs necessary to bring an asset to its intended use or working condition—such as delivery, installation, and testing—are capitalized. Ongoing maintenance or administrative overhead is expensed.
  
  

How It Impacts Financial Statements

The way you treat transaction costs—whether you capitalize them or expense them—has a direct effect on how your financial health appears to internal stakeholders, external investors, and regulatory bodies. Even though the costs may be the same, the presentation of those costs can paint very different pictures.

Let’s break down how this plays out across key financial statements:

On the Balance Sheet

When transaction costs are capitalized, they don’t show up as an immediate expense. Instead, they’re added to the value of an associated asset or liability—effectively increasing that item’s book value.

• For example, legal fees tied to a building purchase would increase the asset’s recorded cost.
  
  
• Underwriting costs from issuing a bond would be included in the carrying value of the debt.
  
  

These capitalized costs are then amortized or depreciated over the asset’s useful life or the term of the liability. That spreads the impact over multiple periods and avoids large single-period hits.

On the Income Statement

When costs are expensed, they’re recognized immediately as a reduction in income for the current reporting period.

• This has a direct impact on net income, which can make earnings appear lower during quarters or years when deals or acquisitions are more active.
  
  
• That short-term volatility can be misleading if not clearly disclosed, especially in industries with frequent transactions.
  
  

While expensing provides a more immediate snapshot of current profitability, it can also obscure long-term investments if not contextualized properly.

On the Statement of Cash Flows

Transaction costs also affect how cash movements are reported:

• Capitalized costs typically appear under investing or financing activities, depending on the nature of the transaction (e.g., asset purchase vs. bond issuance).
  
  
• Expensed costs, on the other hand, reduce operating cash flow, which can influence metrics like EBITDA and free cash flow—important indicators for investors.
  
  

This distinction matters because it influences how a company’s operational efficiency and liquidity appear—especially when comparing performance over time or across peers.

When transaction costs are misclassified or overcapitalized, financial statements can paint a misleading picture, whether intentional or not. That’s why consistent application of accounting standards and clear, transparent disclosures aren’t just best practice—they’re expected. Auditors and regulators tend to zero in on inconsistencies or overly aggressive treatment, particularly during financial reviews, investor reporting, or M&A due diligence.

Managing Transaction Costs Effectively

Transaction costs come with the territory when growing, expanding, or managing capital—but how you account for them can either strengthen financial clarity or chip away at it.

Here are a few tips to manage them wisely:

1. Build Classification into Your Workflow

Set clear internal guidelines on which transaction cost examples should be capitalized versus expensed. Train your finance team to follow these procedures during every transaction.

2. Document Thoroughly

Maintain detailed records that support the business purpose of each cost. This makes audits and compliance checks far easier.

3. Work With Tax Professionals

Some capitalized costs may have favorable tax treatment when amortized over time. A coordinated approach between your CPA and your business ensures alignment.

4. Review Deals Post-Transaction

After closing, evaluate the total transaction cost breakdown and confirm accounting treatment is consistent with standards and documentation.

5. Stay Updated on Guidance

Accounting standards evolve. Changes in how ASC or IFRS frameworks treat certain costs can impact reporting. 

Final Thoughts

Whether you’re acquiring new assets, issuing bonds, or securing financing, transaction costs are part of doing business. But their accounting treatment—capitalized or expensed—can have long-lasting impacts on your financials.

By understanding transaction costs, applying the correct rules under GAAP or IFRS, and proactively managing them, your business can avoid costly mistakes and build stronger financial statements. If you’re unsure whether you’re handling your transaction costs correctly, MB Group is here to help you clarify, comply, and optimize.

Let’s talk about how to streamline your transaction cost accounting—reach out to MB Group today.

Frequently Asked Questions About Transaction Costs

Q: What are the three types of transaction costs in real markets?
The three main types are search and information costs, bargaining costs, and enforcement costs. These cover everything from finding the right party to negotiating terms and making sure agreements are followed.

Q: How are new fees for some transactions explained?
New fees often reflect added complexity, risk, or regulatory requirements. For example, a lender might charge extra for processing a non-standard loan or a legal team may bill more for a cross-border deal.

Q: What is an example of a transaction cost?
A common example is legal fees paid during a company acquisition. Other examples include broker commissions, underwriting fees, and due diligence expenses.

Q: Why are transaction costs important?
Transaction costs can impact the total cost of a deal, affect how profits are reported, and change how financial health is perceived. Properly accounting for them helps ensure accurate reporting and better business decisions.