My company is embarking on a new 5 year office lease this year. As of part of our lease, in lieu of a security deposit, we have established a Standby Letter of Credit (LOC). There is an upfront commitment fee payable to the bank, and the fee will be annually recurring. I'm trying to find guidance in ASC 842 on whether these fees could be capitalized with the right-of-use asset (ROU). I see that "initial direct costs" are includable (ASC 842-20-30-5 Initial Measurement of the Right-of-Use Asset) and such costs are defined as "Incremental costs of a lease that would not have been incurred if the lease had not been obtained". The LOC was certainly obtained solely for the lease, but the examples provided in ASC 842 for initial direct costs, were more like one-time commission fees or buy-out of an existing tenant, not an annual/recurring commitment fees for as long as the LOC is required by the lease. What do members of this forum think? 1) Should all 5 years worth of recurring commitment fees for the LOC be included in the initial measurement of the ROU? 2) Should only Yr 1's commitment fee be be included in the initial measurement of the ROU? 3) The commitment fee does not meet the criteria for "initial direct costs" & should be expensed as incurred ?
Standby Letter of Credit and ASC 842
Answers
Even if you make an argument for the year 1 fee to be an IDC, the fees for years 2 thru 5 will not qualify as "initial costs", by definition. It follows then, what is the point to do the exercise just for the year one fee?
1
True, I guess it's instinct to try and capitalize however much one can if it's allowed.
Thx for responding
ASC 842/IFRS 16 defines initial direct costs as “Incremental costs of obtaining a lease that would not have been incurred if the lease had not been obtained”. This means that costs which are payable regardless of whether the lease is ultimately obtained cannot be capitalised as initial direct costs.
The following costs do not meet the definition of initial direct costs in IFRS 16:
Internal administration and overhead costs that are not incremental.
External costs (such as legal, arrangement and brokers' fees) that are incremental but would still be payable even if the lease was not finalized.
Examples of costs which do meet the IFRS 16 definition of initial direct costs include:
External legal costs to finalize the lease contract after the parties have already committed to the lease (for example, after a binding head of terms has been signed).
For a lessee, arrangement and brokers’ fees payable that is only payable if the lease is signed (that is, success fees).
For a lessor, commission to an employee that is only payable if the lease is signed.
I believe that the above commitment fee in question is outside the ambit of Initial direct costs and should be recorded in terms of variable lease payments not dependent on any index or rate