Accounting

Does Lessee Acquire The Leased Asset For Good?

Under a lease agreement the lessee does not acquires the asset itself but the right to use the asset for a specific time. Leased assets range from physical assets such as land, plant and vehicles, through to intangible assets such as patents, copyright and mineral rights.

Lease agreements may also result in the eventual transfer of ownership from lessor to lessee. For example, under a hire purchase agreement, the lessee will use the asset while paying for its acquisition. The agreed period of time may vary from a short period, such as the daily hire of a motor vehicle, to a longer period, such as the rental of office space by a company. The key feature of leases is the existence of an asset owned by one party (the lessor) but used, for some or all of its economic life, by another party (the lessee).

Service agreements relating to the provision of services, such as cleaning or maintenance, between two parties are not regarded as leases because the contract does not involve the use of an asset. These agreements are regarded as executory contracts — that is, both parties are still to perform to an equal degree the actions required by the contract.

Thus, each party is regarded as having a right and obligation to participate in a future exchange or, alternatively, to compensate or be compensated for the consequences of not doing so. A cleaning contract entitles an entity to receive cleaning services on a regular basis and creates an obligation to pay for those services after they have been received. The key issue is the performance of the service. Until the cleaning services are delivered, the contract is merely an exchange of promises, not of future economic benefits.

The existence of a non-cancellable service agreement or one that includes significant penalties for non-performance may, however, result in the service recipient acquiring control over future economic benefits (the right to receive cleaning services) that are likely to be delivered and can be reliably measured — in other words, an asset.

Accounting for leases is complicated by the fact that there are two parties involved — the lessor and the lessee.

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