Question

Where a lessee incurs initial direct costs in establishing a lease agreement, how are these costs to be accounted for?

a. Expensed immediately
b. Capitalized and amortized over the lease term
c. Ignored in financial statements
d. Recorded as liabilities

Answer 1

When a lessee incurs initial direct costs in establishing a lease agreement, these costs are generally capitalized and amortized over the lease term. This ensures that the costs are matched with the benefits derived from the lease over its useful life.

Step-by-step explanation:

When a lessee incurs initial direct costs in establishing a lease agreement, these costs are generally capitalized and amortized over the lease term. This means that the costs are initially recorded as an asset on the balance sheet and then gradually recognized as an expense over the life of the lease. The amortization expense is typically recorded as an offset to the lease liability.

For example, if a company incurs $10,000 in direct costs to negotiate and prepare a lease agreement that will last for 5 years, the $10,000 will be recognized as an asset on the balance sheet and then amortized ($2,000 per year) over the 5-year lease term.

This accounting treatment ensures that the costs associated with establishing the lease agreement are matched with the benefits derived from the lease over its useful life.