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Accounting for leases

Figure 4-1
Examples of costs included and excluded from initial direct costs

Included Excluded

□ Commissions (including payments to □ Employee salaries
employees acting as selling agents)
□ Internal engineering costs
□ Legal fees resulting from the execution of
the lease □ Legal fees for services rendered before the
execution of the lease
□ Lease document preparation costs incurred
after the execution of the lease □ Negotiating lease term and conditions

□ Certain payments to existing tenants to □ Advertising
move out
□ Other origination efforts
□ Consideration paid for a guarantee of a
residual asset by an unrelated third party □ Depreciation

□ Costs related to an idle asset

Any costs that would have been incurred even if the lessee or the lessor failed to execute the lease are
not incremental costs and should be excluded from initial direct costs. Determining whether a
payment is an incremental cost may depend on the facts and circumstances. For example, ASC 842-
10-55-240 through ASC 842-10-55-242 provides an example in which external legal fees are excluded
from initial direct costs because the lessee would be required to pay its attorneys for negotiating the
lease even if the lease were not executed. However, when a lessee and lessor execute a legally-binding
lease commitment prior to drafting the lease agreement, legal fees for drafting may be incremental
costs that can be accounted for as initial direct costs.

Sales tax payments

Some leases of equipment require that the lessee make sales tax payments directly to a taxing
authority. The specifics of each arrangement vary greatly by jurisdiction. Certain sales taxes may be
considered lessee costs. If this is the case, the sales tax payment is not a lease payment. We believe that
a lessee must carefully assess when the legal obligation arises for the sales tax in order to determine if
the amount should be recorded as an initial direct cost.

If a legal obligation that requires the lessee to pay sales tax arises at lease commencement, it should be
accounted for as a liability and an initial direct cost. For example, if a lessee enters into a 5-year lease
with a rent payment of $100 per year and is obligated to pay $8 as sales tax per year to the taxing
authority whether or not the lease is cancelled, the lessee should record $40 ($8 per year × 5 years,
ignoring present value for example purposes) as a separate liability (i.e., not a lease liability) and initial
direct costs at the lease commencement date.

If the legally obligating event to pay sales tax occurs over time, sales tax should be accounted for as
incurred. For example, if the rent is billed every month (whether at the beginning or end of the

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