In accounting, the terms “lessor” and “lessee” are used to identify the different parties involved in a lease agreement. This distinction is important, because lease accounting as a lessor is significantly different from lease accounting as a lessee. When the various accounting boards for United States, international, and government entities issued new lease accounting standards, the underlying definitions of lessor and lessee did not change. However, the differences between lessor and lessee accounting under the new lease accounting standards are explained in detail below.
A lessor is defined as an entity (i.e. a person, a company, or an organization) that provides the right to use an asset for a period of time in exchange for consideration. One of the more common scenarios of a lease agreement is an entity renting their owned property to another entity for a monthly cash payment. For example, if an organization owns a building and leases out the floor space to a tenant, the owner of the building would be considered the lessor.
A lessee is an entity that obtains the right to use an underlying asset for a period of time in exchange for consideration. In simpler terms, a lessee is defined as an entity that pays for the use of specific property from a lessor. For example, if an organization leases a vehicle from a car dealership, the organization using the car would be considered a lessee. Conceptually, the lessee is paying the lessor for the “right to use” this asset. This is why the lessee, in accordance with the new lease standards, is required to recognize an intangible “right-of-use asset” or a “lease asset” when accounting for the lease. It is important to note that this asset is classified as an intangible asset, rather than a fixed asset, on the lessee’s books.
New lease standards have been released over the last few years, impacting companies that comply with United States, international, and governmental accounting standards. The primary change in the new lease accounting standards is that organizations must recognize lease assets and liabilities on the balance sheet for almost all of their lease arrangements. The governing boards created new standards for lease accounting based on feedback from investors and users of financial statements requesting more visibility regarding future lease obligations or lease receivables.
Under the new lease accounting standards, lessees are required to calculate the present value of future lease payments to establish a lease liability and record the related right-of-use asset. The lessor accounting differs depending on the standard. Below are summaries of lessee and lessor accounting under each of the new lease accounting standards.
Under ASC 842, the new lease accounting standard for US companies following US GAAP, lessees are required to recognize lease assets and lease liabilities on their balance sheets for both operating and finance (previously capital) leases. The lessee is required to perform a present value calculation of future expected lease payments to establish the lease liability and the related lease asset. Accounting for leases classified as operating leases is the most affected, as leases classified as capital leases were already recognized on the balance sheet prior to the effective date of ASC 842.
The accounting for the lessor is largely unchanged from ASC 840 to ASC 842. Lessors should continue to recognize lease income for their leases, and there is not a major change to the balance sheet recognition requirements. The asset being leased will continue to be classified as the lessor’s fixed asset.
IFRS 16, the new international accounting standard, also requires lessees to recognize a lease liability calculated as the present value of the expected lease payments and the related lease asset. An additional change for IFRS users is that, unlike US GAAP, all leases will be classified as finance leases. IFRS 16 requires a single model approach, whereby the operating vs. capital lease classification is no longer applicable under IFRS 16.
While the lessee model under IFRS 16 is a single model approach, for lessors, the operating and finance classification model continues. Under IFRS 16, lessors are required to determine if a lease is classified as an operating or finance lease and use the appropriate accounting treatment.
The main driver between operating and finance leases for lessors under IFRS 16 is transfer of ownership. Lease agreements where the lessor maintains ownership are considered operating leases. For operating leases, the lessor continues depreciating their asset being leased and records the incoming lease receipts as revenue on a straight-line basis. If the lease agreement is classified as a finance lease, the lessor will calculate the net investment in the lease using the present value of future expected lease payments and record this amount as a receivable. Lessors are also required to derecognize the carrying value of the underlying asset. Any difference between the net investment in the lease, and the carrying value of the underlying asset, will be recognized as a gain or loss on the income statement.
Government entities reporting under GASB 87 are required to recognize a lease liability and related lease asset at the lease commencement date, or the transition date to GASB 87 if commencement is prior to transition. The lease liability is equal to the present value of the expected lease payments over the least term and the related lease asset is equal to the lease liability with a few minor adjustments. Like IFRS 16, GASB 87 also uses a single model approach, in which all leases will be classified as finance leases. Similar to ASC 842 and IFRS 16, capital (now finance) leases were previously recorded on the balance sheet as a capital asset and a capital lease liability, but under the new standard recognizing a lease liability and a lease asset for all previous operating leases is a significant change.
Lessors under GASB 87 are required to record a lease receivable and deferred inflow of resources at the commencement of the lease term. As with the lease liability for a lessee, the lease receivable is calculated as the present value of the expected lease payments to be received during the lease term. The deferred inflow of resources is treated as deferred revenue and is equal to the lease receivable with a few minor adjustments.
The GASB intended for the lessor accounting to effectively mirror the lessee accounting under GASB 87, which is accomplished by both the lessor and the lessee being required to recognize, on the balance sheet, the present value of the expected future lease payments or receipts.
Lessee accounting examples
We have several blogs that include detailed examples of lessee accounting under ASC 842, IFRS 16, and GASB 87.
The example below provides journal entries for a lessor’s accounting for a lease arrangement under GASB 87 on the effective date of the agreement, the first month, and subsequent months. We will assume the following lease terms and background information in our example of a building lease from the perspective of the lessor:
- Possession Date: 1/1/2020
- Transition Date: 1/1/2020
- Lease End Date: 12/31/2024
- Base Rent Payment: $10,000/ month (due on the first day of each month)
- Lease Incentive paid 1/1/2020: $10,000
- Discount Rate: 2%
1) Initial Journal Entry
As a lessor reporting under GASB 87, the initial journal entry establishes a lease receivable and a deferred inflow of resources on the lease commencement date. The lease receivable will be measured at the present value of expected lease payments to be received during the lease term. The deferred inflow of resources will be measured at the lease receivable balance, taking into account any prepayments received or incentives paid. Specifically, the lessor will add prepayments received, and subtract any lease incentives paid at or before lease commencement from the lease receivable balance to determine the balance of deferred inflow of resources.
In this example, there is an incentive paid by the lessor on the lease commencement date. Therefore, the incentive payment of $10,000 will be subtracted from the lease receivable balance to calculate the deferred inflow of resources at lease commencement.
As presented in the amortization table below, the present value of the remaining lease payments at lease commencement, discounted at the 2% rate, results in a lease receivable recognized of $570,548. After accounting for the incentive payment the lessor made to the lessee, the deferred inflow of resources recognized was $560,548.
Below is the beginning of the amortization table and corresponding journal entry:
|Cash (incentive paid)||10,000|
|Deferred Inflow of Resources||560,548|
2) Subsequent Journal Entry
At the end of the first month of the lease term, and for all subsequent months, the receipt of cash, interest revenue, and lease revenue will be recorded. Cash received equals the $10,000 lease payment as specified in the lease.
At the end of January, interest revenue is calculated at the daily discount rate times the beginning of the month lease receivable balance times the number of days in the month. In this example, the calculation for interest revenue in January 2020 is as follows: Start with the 2% discount rate and divide the rate by 365 days in a year to calculate the daily rate of interest. Then multiply the daily rate by the number of days in January. Lastly, multiply this sum by the 1/1/2020 lease receivable balance of $570,548 to arrive at $969 of interest revenue for the month.
The credit, or reduction of, the lease receivable is the difference between the cash received and interest revenue. In this example, the calculation of January 2020 receivable reduction is as follows: The cash receipt of $10,000 subtracted by interest revenue for the month of $969 equals a receivable reduction of $9,031 in January.
Lease revenue is recorded as the straight-line amortization of the deferred inflow of resources over the term of the lease, offset by the reduction of the deferred inflow of resources. In this example, lease revenue is calculated by dividing the beginning deferred inflow of resources balance by the number of months in the lease term ($560,548/60 = $9,342 monthly recognition of lease revenue and of monthly amortization of deferred inflow of resources.)
|DR||Deferred Inflow of Resources||9,342|
In subsequent months, a similar entry will be recorded, with the interest revenue and lease receivable reduction changing as the lease receivable reduces.
GASB 87 RFP template
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