Lease Commission Amortization: Lessee and Lessor Schedules

Lease commission amortization starts with one question: was the commission owed only because the lease was signed? If so, it is an initial direct cost (ASC 842-10-30-9 lists commissions as an example). The lessee capitalizes it into the right-of-use asset under ASC 842-20-30-5 and spreads it over the lease term. An operating lessor defers it and expenses it on the same basis as lease income, under ASC 842-30-25-11(c).

Sales-type and direct financing leases work differently for the lessor, and this page covers those too. It then runs one five-year office lease through both sides of the deal, with every input stated.

What counts as initial direct costs under ASC 842?

The ASC 842-10 glossary (ASC 842-10-20) defines initial direct costs as "incremental costs of a lease that would not have been incurred if the lease had not been obtained." The test is simple to say. If the lease had fallen through, would you still owe the cost? If yes, it is not an initial direct cost.

ASC 842-10-30-9 gives two examples for a lessee or a lessor: commissions, and payments to an existing tenant to get it to terminate its lease.

ASC 842-10-30-10 then lists what is out. Costs to negotiate or arrange a lease that "would have been incurred regardless of whether the lease was obtained, such as fixed employee salaries," do not qualify. Neither do general overheads, the lessor's advertising and soliciting costs, or pre-signing work such as tax or legal advice and evaluating the tenant's credit.

The table below sorts the common costs of signing a lease against those two paragraphs.

This is narrower than the old rules. Deloitte's Leasing Roadmap, section 6.11 says the ASC 842 definition "is considerably more restrictive than the definition under ASC 840." Allocated internal costs and legal fees used to qualify. They no longer do.

What does the Codification's broker-commission example show?

A broker commission is the textbook case. Example 27 of ASC 842 shows why. ASC 842-10-55-241 says the lessor's "$10,000 in broker commissions is an initial direct cost because that cost was incurred only as a direct result of obtaining the lease." In the same example, the lessor's legal fees and allocated staff time do not qualify.

The word that matters is "incremental." A commission owed only on a signed lease passes. A fixed salary for your in-house leasing staff fails, because you pay it whether or not the deal closes.

One wrinkle is a contract with a lease and a nonlease component, such as a lease that bundles in maintenance. KPMG's Handbook: Leases (paragraph 5.5.50) notes that judgment is involved in deciding whether a broker commission relates to the lease, the nonlease component, or both.

Under ASC 842-10-15-33, a lessee allocates initial direct costs to the separate lease components "on the same basis as the lease payments." Deloitte's section 6.11 walks through the lessor side of the same allocation.

How does a lessee amortize a lease commission?

The lessee puts the commission into the right-of-use asset at commencement. ASC 842-20-30-5 starts the cost of that asset with the initial lease liability. It adds payments made at or before commencement, less incentives received. It also adds "any initial direct costs incurred by the lessee."

KPMG's Handbook: Leases, paragraph 6.3.70, shows the same build-up for both finance and operating leases. Our right-of-use asset calculation guide walks through the other pieces.

How the commission leaves the asset depends on classification. On an operating lease, ASC 842-20-25-8 includes "the total initial direct costs attributable to the lease" in the remaining cost of the lease. ASC 842-20-25-6(a) spreads that cost as a single lease cost, generally straight-line. ASC 842-10-55-242 says the lessee in Example 27 "amortizes those costs ratably over the lease term as part of its total lease cost."

On a finance lease, the commission sits inside the right-of-use asset and is amortized with it. ASC 842-20-35-7 calls for straight-line amortization unless another systematic basis better reflects how the asset is used. ASC 842-20-35-8 sets the period: to the earlier of the end of the asset's useful life or the end of the lease term. A transfer of ownership, or a purchase option the lessee is reasonably certain to exercise, extends it to the underlying asset's useful life.

Worked example: a lessee's commission amortization schedule

A private company signs a five-year office lease. It hires its own tenant broker and pays the commission in cash at commencement. The lease is classified as an operating lease. Here is every input:

The lease liability is the present value of five $100,000 payments at 6%. The annuity factor is (1 − 1.06⁻⁵) ÷ 0.06 = 4.212364. So the liability is $100,000 × 4.212364 = $421,236. Our lease liability guide covers that formula.

The right-of-use asset is $421,236 + $15,000 = $436,236. At commencement, debit the right-of-use asset $436,236. Credit the lease liability $421,236 and cash $15,000.

The single lease cost is total payments plus the commission, spread evenly. That is ($500,000 + $15,000) ÷ 5 = $103,000 a year. Of that, $15,000 ÷ 5 = $3,000 is the commission. The table below tracks the liability, the commission and the asset year by year.

Interest is rounded to the dollar. Year 5 interest is set at $5,661 so the liability closes at zero. Total interest of $78,764 equals $500,000 of payments less the $421,236 starting liability.

In this example, with level rent, no incentives and no impairment, the closing right-of-use asset is the closing liability plus the unamortized commission. That follows ASC 842-20-35-3(b), which measures the asset at the liability adjusted for items that include "unamortized initial direct costs." In year 1, the asset falls by $436,236 − $358,510 = $77,726. That is the $103,000 lease cost less $25,274 of interest.

Suppose the same lease were a finance lease.

Assume no ownership transfer, no purchase option the lessee is reasonably certain to exercise, and a useful life of at least five years (ASC 842-20-35-8). The asset is then amortized straight-line over the five-year term at $436,236 ÷ 5 = $87,247 a year. Interest is shown separately, so year 1 expense is $87,247 + $25,274 = $112,521. The commission's share of the amortization is still $3,000 a year.

How does lessor lease commission accounting work?

For the lessor, classification decides whether the commission is spread or expensed at once. Our lessee vs. lessor guide covers which side records what. The table below maps each lessor classification to its treatment.

When the commission is deferred on a sales-type lease (ASC 842-30-25-1(c)) or a direct financing lease (ASC 842-30-25-8), there is no separate balance to track. The rate implicit in the lease is defined so that deferred initial direct costs "are included automatically in the net investment in the lease." KPMG's Handbook reproduces both paragraphs in section 7.3.1.

The commission comes back through a lower yield on the receivable. Our direct financing lease guide shows that measurement.

PwC's Leases guide, section 4.3 puts the sales-type rule plainly. Initial direct costs "should be recognized as an expense unless the fair value of the underlying asset equals its carrying amount at lease commencement."

Worked example: an operating lessor's commission schedule

Take the landlord on the same five-year office lease. It pays its leasing broker $30,000 in cash at commencement. Rent is $100,000 a year, level, so straight-line lease income is also $100,000 a year. The lease is an operating lease for the landlord.

The entry at commencement is a debit to deferred initial direct costs of $30,000 and a credit to cash of $30,000. KPMG's Handbook, paragraph 7.4.10, lists this deferral among what an operating lessor does at commencement. Each year, the landlord expenses $30,000 ÷ 5 = $6,000, or $500 a month. The table below runs the deferred balance down to zero.

The pattern mirrors ASC 842-10-55-241, where the lessor "recognizes ratably over the lease term" its $10,000 of commissions, "consistent with its recognition of lease income." If the rent escalated, lease income would generally still be straight-line (ASC 842-30-25-11(a)). The commission expense would follow that same basis. Our ASC 842 journal entries guide has the rent-side entries.

Frequently asked questions

Are leasing commissions initial direct costs?

Yes, when a commission is owed only because the lease was signed. ASC 842-10-30-9 names commissions as an example of an initial direct cost for a lessee or a lessor. Costs you would have paid anyway, such as fixed salaries or legal fees to negotiate the lease, are excluded by ASC 842-10-30-10.

Over what period does a lessor amortize a commission on an operating lease?

Over the lease term. ASC 842-30-25-10 has the lessor defer the commission at commencement. ASC 842-30-25-11(c) then expenses it over the lease term on the same basis as lease income, which is generally straight-line.

Sources and further reading

• Deloitte DART, Leasing Roadmap, 6.11: Initial Direct Costs (reproduces the glossary, ASC 842-10-30-9 and 30-10, and Example 27)
• PwC Viewpoint, Leases guide, 4.3: Initial recognition and measurement, lessor
• KPMG, Handbook: Leases (sections 5.5, 6.3.70, 7.3.1 and 7.4.10)

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