A is corrent. Initial direct costs are costs incurred in connection with the negotiation and consummation of leases, such as legal fees, commissions, etc. For sales-type leases, profit or loss is recognized upon inception of the lease. In keeping with the matching principle, the costs of consummating that lease should be taken into income at the same time as the resulting profit or loss. Therefore, initial direct costs for sales-type leases are expensed currently.
B is incorrect because initial direct costs are capitalized and amortized on a straight-line basis over the lease term for operating leases. Initial direct costs of capital leases may or may not be capitalized. For direct financing leases, these costs are capitalized and amortized by the interest method as a decrease in yield. Conversely, initial direct costs of sales-type leases are not capitalized.
C is incorrect because initial direct costs are not capitalized for all types of leases.
D is incorrect. Initial direct costs which are expensed do not appear on the balance sheet. Capitalized initial direct costs are shown separately as a deferred charge on the lessor’s balance sheet, net of accumulated amortization. They do not reduce the amount of the capitalized leased asset.
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