Question

What are “initial direct costs” and how are they accounted for?

Short answer

Initial direct costs are additional costs resulting from the lessee arranging, completing, and initially managing the leasing transaction.

Step-by-step solution

Meaning of initial direct cost

Internal direct costs are specifically related to the activities conducted by the lessor on a particular lease. Internal indirect costs should not be included within the unique direct costs. Such costs are caused as a result of the lessor's activities, such as promoting, overhauling current leases, and making and observing credit approaches.

Explaining the accountability of initial direct costs

In the case of operational leases, the lessor should defer early direct expenses and allocate them over the lease period in proportion to rent revenue recognition. The lessor deducts the initial direct costs in the year of incurrence in a sales-type lease arrangement (i.e., the year in which profit on the sale is recognized).

Initial direct expenses should be included in the net lease investment and amortized throughout the lease's duration as a yield adjustment in a direct-financing lease.