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IAS 17 - Meaning of incremental costs

Date recorded:

The Committee was requested to provide guidance on whether fixed staff costs (employees on payroll who spend all (or substantially all) of their time on the negotiation, arranging and creation of new transactions (leases and loans)) can qualify as "incremental costs" in terms of initial direct costs as specified in IAS 17. It is unclear how the requirements in IAS 17 are applied and therefore there are two alternative views being applied in practice.

View A: internal fixed costs (such as the staff costs set out above) do not qualify as ‘incremental costs’ and therefore should not be included as initial direct costs in the lessor’s lease receivable.

View B: internal fixed costs (such as the staff costs set out above) do qualify as ‘incremental costs’ and therefore should be included as initial direct costs in the lessor’s lease receivable.

Staff presented their analysis to the Committee where they concluded that internal fixed costs do not qualify as incremental costs. Only those costs that would not have been incurred if the entity had not negotiated and arranged a lease should be included in the initial measurement of the finance lease receivable. In addition, Staff noted there appears to be no diversity in practice in relation to this issue.

Staff recommended the Committee do not take this issue onto its agenda and presented their proposed wording for a tentative agenda decision.

A member agreed with Staff’s recommendation but wanted to understand how this would fit with the revenue recognition exposure draft (ED) on incremental cost. Other members raised the question in relation to the developments of the insurances and leases Standards. 

Staff said that the treatment is very similar in relation to revenue, costs are incurred when certain events take place. With regards to insurance there is no notion of incremental costs, they look at cash flows. On leasing, the IASB was undecided if incremental costs would be included or excluded.

Another member added that incremental costs directly related should be deferred.

A member commented that fixed costs are not permanently fixed and therefore they can be incremental. He gave an example of staff costs, as staff could leave at any point in time or could be made redundant.

The Chairman added that the insurance Standard is based on a portfolio basis and therefore it may not be relevant for the purpose of this discussion. The issue that the Committee should focus on here is if one extra lease contract would make a difference in staff costs and therefore such a cost be incremental.

A member raised the following four points to the Committee:

  1. the definition of incremental is different in each standard and therefore the Committee should work towards a common definition, for example in IAS 39 the notion of incremental is not the same as that of IAS 17;
  2. the direct cost definition in the lease ED is not different to IAS 17;
  3. the member is surprised to see limited diversity in practice; and
  4. it was worrying to see that insourced costs were not capitalised where as if the cost was outsourced it would be capitalised. This could lead to a potential anomaly.

Another member agreed with Staff’s recommendation but commented that even costs that are fixed in the short term, over time can be variable.

Another member agreed with Staff and said that costs that were outsourced cannot necessarily be incremental where the cost of say 1 contract was the same as that of 100. However if staff were paid bonuses on completion of a contract then it could be argued that this is an incremental cost.

A member said that under US GAAP, direct internal costs relating to a lease can be capitalised. In addition outsourced incremental costs would also be capitalised.

Another member added that in Germany there is no diversity in practice, a company can structure it such a way that certain costs could be capitalised for example by having low salaries and bonuses on completion.

The Chairman concluded the meeting by saying that although the majority of the Committee agreed with Staff’s recommendation Staff need to explore the definition of what incremental means in IAS 17.

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