Initial direct costs are a direct result of obtaining a lease
Anytime you enter into a lease agreement — or any type of contract, for that matter — you have the potential to incur additional costs that you only incur as a direct result of the lease itself. These expenses, known as initial direct costs, are those associated with acquiring a lease. They can include finder’s fees, agent commissions, legal fees that are contingent on the successful execution of the lease, and more. Generally speaking, expenses that are included in initial direct costs are those that wouldn’t be incurred if the lease wasn’t ultimately executed.
Example:Suppose you do accounting for a municipality that’s preparing to enter into a new lease agreement. Before signing the lease, you incur a number of additional expenses, including negotiating costs and legal expenses. Once the lease is successfully executed, you take on even more costs, including agent commissions. But only those direct costs that occur as a result of the execution of the lease are initial direct costs.
Not all expenses associated with obtaining a lease are necessarily initial direct costs. For a cost to be included, it must be incremental. As a result, an organization couldn’t allocate a portion of its administrative, finance, or management budget to it.
Other costs that aren’t initial direct costs would include employee salaries, negotiation costs, legal fees that aren’t contingent on the successful execution of the lease, advertising, depreciation, and more. In other words, any costs you would have incurred if the lease agreement had fallen through aren’t initial direct costs.
What’s important here?
Only those direct costs that occur as a result of the execution of the lease are initial direct costs.
