Navigating leases can be a challenge, especially when it comes to distinguishing between a lessee and a lessor. At their very heart, leases require two key players. One is the lessor, the party that has an asset available for leasing, and the other is the lessee, the party that pays to use the asset. This lessee vs. lessor dynamic is at the core of lease accounting.

But how do financial statements differ for both parties? What rights do lessees have? And why is using software to adhere to lessor/lessee accounting the best option for an organization? Let’s start with some definitions.

What’s the Difference Between a Lessee vs. Lessor?

A lessor is someone who grants the use of an asset to someone else; they have legal rights to lease an asset under an agreement. The lessor also has the ability to grant special privileges to the lessee, such as early termination of the lease or renewal on unchanged terms.

An advantage of being a lessor is that in granting someone the ability to use your property, you get a return on your investment in that property without giving up ownership.

A lessee in contrast is someone who makes a one-time payment or a series of payments to the lessor in exchange for using their property. They do not own that which they lease; they only temporarily have the ability to utilize it. If ownership transfers from lessor to lessee, there is no longer a lease.

An advantage of being a lessee is that it may be easier to finance the use of property temporarily instead of purchasing that asset outright. Sometimes the needed asset might only be available through a lease.

What Is an Example of a Lessee vs. Lessor?

A lessor can be either an individual or a legal entity, like a business or organization. The lessor is either the owner of the asset or has the legal right to lease the asset to someone else. For example, if a car is the asset in question, the lessor would be the property owner or auto dealer leasing out the car.

The lessee is the one paying to use the asset for a period of time. They do not own the asset throughout the lease. If ownership does transfer to the lessee at the end of the lease term, that transfer ends the lease. In our car example, a lessee would be the individual or entity to whom the car is on loan from the dealer or property owner.

Is a Lessee a Tenant or Landlord?

When the asset under lease is a piece of real estate, then the lessee is a tenant and the lessor is the landlord. The lessee is the temporary occupant of the property, and the lessor owns the property which the lessee is occupying.

Lessee vs. Lessor Accounting

With the advent of the new lease accounting standards, lessors and lessees also have to change how they document leases on their financial statements. Documentation is now different for lessees and lessors in the following ways:

ASC 842

Under ASC 842, which replaced ASC 840, there are nominal changes to how lessors document their leases. The big effect of the new lease standard is on lessees, who must add operating lease ROU Assets and Lease Liabilities onto their balance sheets. Take a look at our resource which shows a side-by-side comparison of ASC 840 lease accounting and ASC 842 lease accounting.

IFRS 16

Similar to ASC 842, IFRS 16 from the International Financial Reporting Standards requires lessees to recognize all leases on their balance sheets. The difference between IFRS 16 and ASC 842 is that lessees following IFRS 16 have only one lease type, similar to the finance lease under ASC 842. As a result, implementing IFRS 16 affects lessee income statements in addition to the balance sheet. Under this standard, lessor accounting is substantially unchanged.

GASB 87

Under GASB 87, lessors record a lease receivable and a deferred inflow of resources at the commencement of the lease term. A lease receivable is calculated as the present value of the lease receipts expected during the lease term. Much like IFRS 16, there is only one type of lease for all leases, similar to the finance lease under ASC 842.

Lessees are required to recognize a lease liability and a lease asset at the commencement of the lease term. The lease liability is the present value of future payments expected to be made over the course of the lease. The leased asset, representing the lessee's right to use the leased property, is measured as the initial amount of lease liability plus any payments made to the lessor at or before the time of commencement of the lease, and minus any lease incentives received from the lessor. The lease asset is then amortized over the shorter of the lease term or the useful life of the underlying asset.

How are Lease Modifications Handled Differently by Lessors and Lessees Under ASC 842?

A lease modification is a change to the terms and conditions of a lease that was not part of the original lease agreement. A lease modification should be recorded as a separate contract when it grants additional rights to use that are not in the original contract and the lease payments increase commensurate with stand alone pricing.

Lessees and lessors handle modifications differently based on the type of change. In some scenarios, a lessee or lessor will modify the existing lease by freezing the original calculations and making an adjustment moving forward. When the modification meets the criteria above, it is recorded as a new lease and the original lease calculations will not change.

How Do Lease Incentives Impact the Accounting for Both Lessors and Lessees?

When accounting for lease incentives, the timing of the incentive will dictate how it’s accounted for. Payments made to or on behalf of the lessee at or before the start of the lease are not included in the lessees calculation of Lease Liability and will reduce the ROU Asset. Payments expected to be made at a later date should be processed as a negative payment that reduces the Lease Liability and ROU Asset. If a lessee receives an incentive it wasn’t expecting after the commencement date of the lease, they should process a modification of the lease. 

When an incentive is paid by a lessor, the payment is recorded as part of deferred rent for operating lease classifications. If the payment is expected to be made after the commencement of the lease, similar to the lessee calculations, a negative payment should be recorded.

Why Software Is the Best Option for Lessee vs. Lessor Accounting

Documenting lessee vs. lessor information on your financials can be difficult. With guidelines becoming increasingly complicated for both lessors and lessees when it comes to documenting their leases, using software to quickly and accurately calculate ROU Assets and Lease Liabilities is becoming more popular. LeaseCrunch provides software that makes lease accounting a seamless, quick, error-free process. Our software is:

Efficient

Never again do a manual calculation for lease accounting. Eliminate manual data entry errors and increase the accuracy of your financial statements with our automated software.

Easy To Use

Our software crunches the numbers behind the scenes, meaning most of your accounting work is interacting with our user-friendly interface and in-line resource guide.

Customizable

Our software is completely scalable to your business size, no matter how small or large.

Secure

We have embedded security measures in our software to keep your financial data safe.

Developed By Experts 

LeaseCrunch is founded collaboratively by CPAs who have lived in both the public accounting and private industry world, along with software professionals who ensure our ease of use, accuracy, and security protocols are paramount throughout the software.

Not looking forward to calculating journal entries and extensive disclosures under the lessee vs. lessor accounting standards? Let us deal with it. Try out our software and learn how simple it all can be. Reach out to us today for a demo.

Frequently Asked Questions

What Are the Rights of a Lessee?

In a lessee vs. lessor agreement, the lessee has the right to use the leased property or equipment for the duration of the lease agreement. In return, they are obligated to make timely lease payments as outlined in the agreement, typically maintaining the asset and making sure it is in good condition, barring normal wear and tear.

What Is the Difference Between a Renter and a Lessee?

The term "lessee" is more commonly used in formal or legal contexts, including both real estate and equipment leasing. "Renter" or “tenant” is often used in more casual, everyday language, typically referring to someone leasing residential property. Lessee, renter, and tenant have essentially the same meaning. 

What Does Lessee Mean in Law?

In legal terms, a lessee is a person or entity who enters into a contract, known as a lease, with the owner of an asset (the lessor). This contract grants the lessee the exclusive right to use and occupy the asset for a specified period in exchange for regular payments. The lease contract binds the lessee to certain obligations, such as payment terms and maintenance responsibilities.

Is the Lessee the Owner of an Asset?

No, the lessee is not the owner of the asset. In a leasing agreement, the lessee is granted the right to use the asset for a specified time period, but the ownership remains with the lessor. The lessee makes regular payments for this usage, but at the end of the lease term, unless there's an option to purchase, the asset typically reverts back to the lessor.

What is lessor’s risk insurance?

Lessor’s risk only (LRO) insurance protects lessors against the risk of certain lawsuits from their tenants.

Who are the lessor and the lessee in rental agreements?

The lessor in a rental agreement is the party that owns the asset and is renting to the lessee, who is paying for temporary use of the rental.

What are the primary responsibilities of a lessor in a lease agreement?

A lessor’s responsibilities vary based on the lease agreement, but typically they must maintain the condition of the leased asset, handling any repairs or maintenance that become necessary throughout the term of the lease. They also must remain compliant with relevant laws and regulations.

How does a lessee's accounting treatment differ from a lessor's under ASC 842?

A lessee is required to recognize lease liabilities and right of use assets on the Balance Sheet. Lessors own the asset that is being leased to the lessee; therefore, a lessor’s recognition depends on the classification of the lease. 

What types of leases are typically offered by lessors?

Under ASC 842, lessors classify leases in one of three ways: sales-type leases, direct financing leases or operating leases. For more information, a guide to commercial lease types can be found here.

What are the financial reporting implications for a lessee under ASC 842?

A lessee is required to report both the lease liability and the ROU asset under ASC 842 to show a more complete financial picture of the debt owed by the lessee.

What are the key differences between a capital lease (finance lease) and an operating lease from a lessor’s perspective?

Lessors do not classify leases as finance leases. Instead the lease classifications for lessors are operating leases, sales-type leases or direct financing leases. For operating leases, the lessor will continue to recognize the asset on their balance sheet. For sales-type and direct financing leases, the lessor derecognizes the underlying asset and recognizes net investment in the lease.

How does the classification of a lease as either operating or finance affect the lessor's financial statements?

How a lease is classified by a lessee does not affect how a lessor reports on the same lease.  

What disclosures are required for lessors under ASC 842?

Key disclosures for lessors under ASC 842 include:

• Information about the nature of its leases
• Significant assumptions and judgements made in applying ASC 842 to the lease
• Lease transactions with related parties
• Components of their aggregate net investment in sales-type and direct financing leases. 
• Information about how they manage risk associated with the residual value of leased assets