Lease Agreements Explanation
A lease agreement is a legal contract between two parties for the usage of an asset or property over a set period of time in exchange for rent payments. The owner of the asset or property allows another party to use the asset or property for payments. Often a lease agreement includes an option to buy the leased asset or simply transfers ownerships to the lessee at the conclusion of the lease.
Parties in a Lease Agreement
The party that owns the asset is the lessor, or the landlord. The party that pays for using the asset is the lessee, or the tenant. The lessee is the party that pays for the usage of the property. The lessor is the party that owns the property and collects rent payments from the lessee.
Advantages of Leasing
A lease agreement can benefit the lessee by giving them access to and usage of an asset they might not be able to afford. For example, if a company is starting up and does not have the capital to purchase expensive equipment or machinery, the company would be better off leasing the equipment or machinery for monthly payments.
A lease agreement can benefit a lessor by turning an unused asset into a source of income. If the lessor owns a valuable asset but is not making use of it, they would be better off leasing it to another party who can make use of it, and in return receive the rental payments.
Types of Lease Agreement
In accounting, there are several types of lease agreements. The conditions of the lease agreement determine how the transaction is recorded in the company’s financial statements. The types of lease include capital lease, operating lease, and sale and leaseback.
In a capital lease, also called a financial lease, the lessee acquires all the benefits and responsibilities of ownership of the property. They must record the lease on their balance sheet as an asset with a corresponding liability.
An operating lease is also called a service lease. The lessor retains all the benefits and responsibilities of ownership. However, the property is not recorded on the lessee’s balance sheet.
Whereas in a sale-and-leaseback agreement, the owner of the property sells it to another party. Then, they immediately lease it back from that party. The owner becomes the lessee and the buyer becomes the lessor. Companies do this to free up cash that may be tied up in an illiquid fixed asset.
See Also:
Lessor versus Lessee
Sale and Leaseback
Capital Lease Agreement
Agency Costs
Make-or-Buy Business Decision
