What is the Meaning of Lessor?
A lessor is defined as the owner of an asset that is rented or leased to another person’s called as lessee under an agreement for a specified period of time. Lessee has to make one time or periodic payment as per agreement to the lessor in return for the use of the assets. Here, the lessor means the owner of property or assets who received the payment and the lessee is the renter who makes lease payment. If any losses incurred during contract due to damage or misuse of assets in question, the lessor must be compensated for that.
Types of Lessor
As per the accounting perspective, it is classified into the below-mentioned types.
#1 – Operating Lease (Lessor Perspective)
In an operating lease, Lessor received periodic interest payments on leased assets and rented assets remain on balance sheets of Lessor which continuously depreciates accordingly fixed assets accounting policy. The income earned on leased assets is recorded on the straight-line basis in the income statement.
#2 – Direct Finance or Capital Lease (Lessor Perspective)
If the current value of rent payment is the same as the value of a leased asset is called Direct Financing and Lessor reports lease receivable in the balance sheet. If current value rent payments of a rented asset are higher than the leased assets It is called a sale type lease.
Examples of Lessor
The following are some of the basic and practical examples.
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Example #1 (Basic)
Let’s say a Denim limited company looking to start a new clothing store in California, but the company not in a position to buy or build a new building. So the company decided to reach out to the first lease limited for renting a store or building. Denim limited signed on three years lease agreement with first lease limited at agreed terms and conditions in the agreement. So here Denim limited is called as Lessee and first lease limited is called as Lessor. Here, first lease limited is the legal owner of the property which they leased to denim limited. Denim limited need to pay back rent amount to the first lease in every month as per agreement terms.
Example #2 (Practical)
Accounting Treatment of Operating Lease (Lessor)
Let’s Assume that an ABC limited company (Lessor) Leases some equipment to XYZ limited (lessee) for 5 years as per agreed terms in the agreement. XYZ limited agrees to Pay $50,000 at the start of each year. ABC limited purchased leased equipment at the cost of $400,000 and it has an estimated life of 10 years. ABC limited uses the straight-line depreciation method. On 1/10/95, he pays the annual insurance premium of $2,000 and in 15/12/95 pays some repair expenses of $1,500. Assuming there is no direct cost initially, the above information is recorded in the following journal entries as per the lessor perspective.
#1 – Purchase of Equipment to be Leased on 1/1/95
#2 – Collection of Annual Payment on Operating Lease on 1/1/95
#3 – Payments of Annual Insurance Premium on 1/10/95 : (An Executory Cost)
Recognition of annual depreciation expense :
Depreciation Expenses = 400,000/10
Depreciation Expenses = 40,000
Advantages
- The lessor who acts smartly or carefully can earn higher profit by leasing the assets and whatever profit he/she earns will cover his cost of capital and risk involved in leasing.
- As Owner of the lessor of the asset can claim various tax benefits so because of this various leasing companies successful implement leasing to minimize the tax liabilities.
- By leasing assets, he/she can earn in short periods rather than investing in a project which has a longer maturity period.
- It also helps in increasing the sale of the manufacturer through lease financing and sometimes lessor also in a position to demand some discount due to an increase in sales.
Disadvantages
- Even if the price of assets changes due to inflation, the lessor will get the fixed cost as per agreed in the lease agreement.
- Due to the competitive market, lessor across all the region lessor has to go through tight competition and may not able to get the expected lease amounts.
- Lessor has to take the risk if the value of assets reduced during the leasing period.
- The business of Leasing is largely depended on efficient management cash flows which are not easy to manage due to Volatility in the market.
Important Points
- Lessor needs to understand the actual Cost of assets.
- The present value of all the lease rentals that Lessor will take out of lessee pockets and put in his pocket as an income. Present values need to be taken care of because in finance main things are present value deduction which is always on discounted values.
- Salvage value of assets also taken into consideration during Leasing.
Conclusion
In this article, we understood what is the meaning of lessor in the lease agreement and how journal entries for lease agreement have reflected the account of Lessor. It holds the legal Ownership of the assets even after the assets leased to the lessee.
There are two important types of the lease agreement as per lessor perspective and which plays important roles in the lease agreement. In leasing Lessor can earn a quick return as compared to investing in different projects which may take a long time to provide the return. Evaluation of Leasing assets is very important for Lessor to avoid risk and to earn a good return on leasing assets.
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