Definition
The financial accounting term initial direct cost is used to describe those costs that are directly associated with negotiating and completing a service agreement. Initial indirect costs consist of sales commissions, legal fees, creditworthiness checks, preparation of documentation, in addition to other costs that are incremental and directly attributable to the agreement.
Accounting conventions dictate these costs should be charged to expense in the same accounting period in which the revenue associated with the service is recognized as being earned.
Explanation
Accounting for initial direct costs is a topic of particular importance to the leasing industry. International Accounting Standards 17 (Leases) states initial indirect costs incurred by lessors should be capitalized and amortized over the term of the agreement. In the past, lessors had the option to treat these costs as an expense.
IAS No. 17 provides guidance for initial indirect costs under three leasing scenarios:
Operating Lease: these costs should be added to the carrying amount of the leased asset, and recorded as an expense over the term of the lease.
Finance Lease (Direct Financing Lease): these costs should be included in the initial determination of the receivable; thereby reducing the amount of income recognized over the term of the lease.
Finance Lease (Sales-Type Lease): indirect costs should be recognized as an expense in the same accounting period as the selling profit.
While initial direct costs incurred by lessors include sales commissions, legal fees and other costs that are incremental and directly attributed to arranging a lease, they exclude general overheads. For example, the typical costs associated with fielding a sales team such as salaries, and marketing expenses such as advertising, would not be considered an initial direct cost.
Related Terms
- The financial accounting term operating lease is used to describe one of several lease arrangements that a company can hold. Operating leases are used to acquire assets on a relatively short-term basis. The cost of an operating lease appears as an expense on the income statement.
Moneyzine EditorNovember 6th, 2024 
The Financial Accounting Standards Board rules allow companies two methods to account for leases. If the agreement meets any of the following conditions, the lease should be treated as a capital lease, also known as a finance lease:Moneyzine EditorNovember 6th, 2024- The term service transaction cost refers to those business expenses associated with providing services to a customer. Service transaction costs generally fall into three categories: initial indirect costs, direct costs, and indirect costs.Moneyzine EditorNovember 6th, 2024
The financial accounting term indirect cost is used to describe all costs other than initial direct and direct costs. Typically, indirect costs do not have a clearly attributable relationship to a product or a service. Indirect costs can include selling, general and administrative expenses, advertising, insurance, and taxes.Moneyzine EditorNovember 6th, 2024
The financial accounting term direct cost is used to describe those costs that have a clearly attributable relationship to a product or service being performed or the level of services being performed for a customer. Direct costs can include labor, material, and other expenses associated with manufacturing a product or providing a service.Moneyzine EditorNovember 6th, 2024
