Accounting For Initial Direct Costs (IDC) in Leases : Initial direct costs (IDC) are incremental costs that are directly attributable to negotiating and arranging a lease, except for such costs incurred by manufacturer or dealer lessors. Examples include commission and legal fees,credit investigation, document preparation and other internal costs, but exclude general overheads such as those incurred by a sales and marketing team.
Initial direct cost incurred by a manufacturer/dealer lessor are excluded from the definition of initial direct costs because, according to paragraph 46, the costs of negotiating and arranging a finance lease are ‘mainly related to earning the manufacturer’s or dealer’s selling profit’. How the IASB reached this conclusion is hard to understand. Thus, for the purposes of determining the interest rate implicit in the lease, any initial direct costs incurred by a lessee or a manufacturer/dealer lessor are ignored. Here is the table prepared for your easy understanding.
Initial Direct Cost in Lessee’s Books of Accounts:
Operating Lease: expended out the costs as incurred
Capital Lease : expended out the costs as incurred
Initial Direct Cost in Lessor’s Books of Accounts:
Operating Lease: Amortize the IDC Straight line over the lease term
Sales Type Lease : Add the IDC to Cost of Goods Sold/expend out in the year the sale is recorded
Direct Financing Lease : Add the IDC to net investment in the Lease
Summary: In case of lessee, all Initial Direct Costs (IDC) are expended out as incurred irrespective of Operating or Capital lease. In case of lessor, all Initial Direct Costs (IDC) are added to COGS if the lease is Sales Type Lease but deferred when the lease is a Direct Financing Lease and amortized over the lease term. If the lease is an operating lease for the lessor, the amortize the IDC Straight line over the lease term. So, no matter for Lessee, all the time it shows Initial Direct Costs as Expenses.