The terms “lessee” and “lessor” are seen all over rental agreements. A lease cannot exist without two parties participating in the agreement. These two parties are known as the lessee and the lessor. It’s important to know the definition of each, as lease accounting differs between the two.
This article discusses the differences between the lessee and lessor as well as how the new lease accounting standards impact the accounting treatment for each party.
A lessee is an entity that is paying for the right to use an asset that’s owned by another party. The contract allows the lessee use of an asset for an agreed-upon price or amount of consideration. For example, if a car dealership leases a vehicle to someone, the car is the asset. The person renting the car is the lessee and the dealership is the lessor. The lessee pays the dealership, or lessor, for the right to use the vehicle for an agreed-upon amount of time. Under the new lease accounting standards, the lessee is required to recognize an intangible right-of-use asset along with a lease liability when accounting for the lease.
A lessor is an entity that is allowing another party to use an asset in exchange for something, such as a cash payment. For example, an entity owning a building may allow a company the right to use its building for office space. The owners of the building are the lessor, the company is the lessee.
A lessor shares similarities with a lienholder, but they aren’t the same. Leases have lessors, and liens have lienholders, also known as lenders or creditors. A lien is the legal right of a creditor to take possession of an asset to fulfill a debt or contractual obligation. A lienholder has a legal interest in an asset for which they provided the funding until the loan is paid in full. A lessor may or may not own the asset which they are leasing to the lessee. If a lease is in default, the lessee loses its right to access the asset.
For example, when a person obtains a car from a dealership, they have the option to buy the car, sometimes by taking out a loan, or to lease the car. In either scenario the entity offering the financing – either the loan or the lease, will likely place a lien on the vehicle being financed. The lienholder then has the right to seize the car if the agreed-upon payments are not made.
Lessee and lessor terms don’t just apply to equipment leasing. In property/real estate rentals, the landlord allowing someone to rent their property is the lessor. The tenant using the property is the lessee.
In commercial real estate agreements, the lessor is the person granting a lease for use of commercial space. The lessee and lessor come to an agreement establishing the lessor’s rights and obligations for the duration of the lease, as well as the periodic payments the lessee will provide to the lessor.
Lessor’s risk only (LRO) insurance protects commercial landlords against lawsuits. This applies to property damage or any bodily injuries a tenant sustains on the commercial property. Also known as landlord insurance, it covers commercial property such as apartment complexes or office spaces.
The new lease accounting standards, ASC 842, IFRS 16, and GASB 87, have changed the way we account for leases. While the definitions for lessee and lessor have remained unchanged, the financial reporting for both lessees and lessors isn’t the same as it was under the previous standards.
ASC 842 requires most leases to be recorded on the balance sheet. Under the new FASB standard, all lessors must classify leases either as a sales-type, direct financing, or operating. Lessees must classify all leases either as finance or operating, as well as calculate the present value of future lease payments to establish the lease liability and related ROU asset.
For a full example of lessee accounting for an operating lease under ASC 842, read “ASC 842 Lease Accounting Summary, Effective Dates, Examples, & More.” For capital/finance lease accounting, read “Capital Lease Accounting and Finance Lease Accounting: A Full Example.”
Lessee accounting for lessees has changed under IFRS 16. Instead of distinguishing between operating and finance leases, a single-model approach is in place. Post-adoption, all material lessee leases must be reported as finance leases. The leases must be capitalized and recorded on the balance sheet as ROU assets and lease liabilities.
Lessors continue to use operating and finance classification. They must figure out if a lease is classified as an operating or finance lease and follow the appropriate accounting methods.
For a full example of lessee accounting under IFRS 16, read “IFRS 16 Leases: Summary, Example, Journal Entries, and Disclosures.”
Accounting has changed to a single-model approach for government entity lessees and lessors under GASB 87. Lessees must recognize a lease liability and related lease asset at the lease commencement date, or the transition date to GASB 87. Lessors must record a lease receivable and corresponding deferred inflow of resources at the commencement of the lease term.
For a full example of lessee accounting under GASB 87, read “GASB 87 Explained with a Full Example of the New Governmental Lease Accounting Standards.” For lessor accounting under GASB 87, read “GASB 87 Lessor Accounting Example with Journal Entries.”
The lessee and the lessor are the two main parties in a lease agreement. Whether an equipment lease or a commercial lease, it’s important to comprehend the particular responsibilities between the two because the accounting differs for each.
The new lease accounting standards impact the financial reporting for both lessees and lessors. LeaseQuery simplifies the transition to the new standards. Schedule a demo to learn the benefits of using lease accounting software for adoption.