 Hello and welcome to this session. This is Professor Farhad in which we will discuss accounting for leases, specifically some miscellaneous issues, be more specific, initial direct cost, executory cost, and lease variable payments. In the prior session, we looked at how to account for depreciation expense for the lessor, amortization of the right-of-use asset for the lessee, and how to deal with bargain purchase option. And we had two separate recordings, one for the guaranteed and unguaranteed residual value, which is, I believe, that session, that issue guaranteed and unguaranteed residual value would warrant its own separate explanation. So let's go ahead and finish those three topics. So you have a good comprehension about this topic, whether you are a student or a CPA candidate. Starting with initial direct cost, what are those? What are initial direct cost? Those are incremental additional cost that occurred, that incurred. It happened. Why? Because the lease transaction took place. What could be some examples? Well, guess what? When you sign a lease, you have to prepare documents. Those documents could be prepared as physical documents. These days are electronic documents. Nevertheless, you have to pay a fee for those document preparation. You might incur legal fees. You have lawyers preparing, reviewing your lease, preparing all the paperwork to make sure everything is correct. Well, those are initial direct cost. Fees paid the third party to guarantee residual value. If you remember when we talked about direct financing leases, we said if there's a third party guarantee in the residual value, it becomes a direct financing lease. Well, again, under those circumstances, what we have here is initial direct cost. Now, how do we treat? How do we handle those initial direct costs? Well, it all depends whether you are the less see or the less sore. If you're the less see, remember the less see is the renter is the person that's leasing the asset so they can use it to produce their goods and services. They're going to include those costs and the right of use asset. Remember, they debit an asset and they credit liability, which is right of use asset. Then what do we do with right of use asset? We amortize it. We amortize the cost, which is it's included. IDC is included over the useful or the least term, whichever is shorter. We discuss this in the prior session. Now, bear in mind, although it's included in the asset, the amount is included in the asset. It's not included in the liability. Hold on a second. Those will not balance. Don't worry, we would look an example. So those are not obligated or included in the asset that they're not part of the liability. Less source perspective, less sore is the owner of the asset. Well, if it's a sales type lease, which is a finance lease, easy, will expense at the inception of the lease and get done with those initial direct costs. If it's an operating lease, we are going to defer those initial direct costs. We're going to defer them and amortize as expense over the life of the lease. What does that mean? It means you will expense them later as you are amortizing the expense. Now, the best way is to look at an example to illustrate this concept. Now, we looked at this example when we talked about a bargain purchase option, where we have a lease with a $10,000 payment three year, assuming 6%, and the bargain purchase option is 500. So we computed the present value of the 10,000, the three payments happens to be 26,730. We computed the present value of the $500, which is the bargain purchase option, happens to be 39105. Now, if you don't know where these numbers are coming from, please look at the prior recording. And the lease liability was $27,111 and 15 cents. Yes, what color? Purple. Okay, purple. Because it works very good. Thank you. Now, so in the prior session, basically you debit an asset for $27,111.15 and we credit the liability for that amount, $27,111.15. Now, assume that we incurred those additional initial direct costs. Let's assume we incurred $1,500. How do we process the transaction? How do we record the transaction? Well, we are going to still record the liabilities at $27 or the liability at $27,111.15. Now, the asset we are going to add to the asset. So this is this supposed to be the asset. We're going to add to the asset $1,500. Therefore, it becomes $28,611.15 and we credit whether we paid cash for those additional costs or if we purchase, if we owe the money, which is a payable. Now, before we proceed any further, I would like to remind you whether you are a student or a CPA candidate and most likely if you are either a student or a candidate looking for some help about this topic. Great. You have arrived for hot lectures.com. This is where I have lectures, multiple choice, true, false, exercises that's going to help you with your accounting courses as well as your CPA exam. I don't replace your CPA review course. I don't replace obviously your accounting course. I can provide you additional help and the mere fact that you are watching it means you are looking for help and I can help you. Check it out. Connect with me only then if you haven't done so, like this recording, share it with other connect with me on Instagram, Facebook, Twitter, and Reddit. Now, let's talk about executory cost. Now, the executory costs are costs only incurred by the less see the person that rent that leases the buildings. Let's assume we're leasing this really fancy building. So for leasing this building, we're going to have to make payments. Also, we might be responsible for paying property taxes for the city, for the state, whatever, insurance and maintenance costs. The question is, how do we handle those executory costs? Well, here's how it goes. If those payments are made directly to a third party, so if we're paying, if we're writing the check right to the county, okay, when the lessor is not getting, not getting the money, then the lessor is paying it, then we expense them. So if they're going directly, if the insurance, we cut the check to first limited insurance company, well, guess what? We expense it because we're making the payments directly to the third party. If those payments, and usually this is what happened on the exam, if those payments are required fixed payment as part of the lease and are made to the lessor, if that's the case, then we treat them as liability. You're gonna have, most likely you're gonna have, you treat them as expenses. Let's talk about variable lease payments. What is, what is variable lease payments is when the payment changes, it varies. So it's not the same amount. Usually it's the same amount, then it's going to vary. It's gonna be a different amount. Well, here's what's gonna happen. Sometime we're gonna know this variance upfront. We're gonna know how much it's gonna vary by. If that's the case, if the amount is known, you include those payments in the liability when you compute the liability. An example will be the payment is being bumped every year by 2500 or the monthly payment. It doesn't matter, but you know the amount and you know when it's going to change. Then that's fine. If the amount is unknown, if the change in the amount is unknown, why would that happen? The payment could be linked to inflation. So whatever happened to inflation will, will, will increase your payment or reduce your payment. These days, well, we're gonna have to increase your payment, right? Because inflation is going up. So if that's the case, if we don't know the amount, okay, then we're gonna expense the variable payment in the year that we pay it. So if we have to pay extra, then it becomes an expense. What should you do now? Go to Farhat Lectures work multiple choice and true false questions. That's gonna help you understand this topic. And I hope you like the purple color that my son suggested. Anyhow, a study hard, stay safe and the CPA is worth it. Invest in yourself and invest in your career. Good luck.