Introduction to Lessor
Lessor refers to the party that grants a right to use a particular asset owned by such party to another party for a certain period against the periodic lease rentals under a lease agreement. The person to whom such right to use the asset is given is known as the lessee. The arrangement is known as a leasing arrangement and allows the lessee to use an asset for a particular period.
Explanation
Leasing arrangement involves a party granting a right to the other party to use an asset for a defined term against the periodic rentals. The party that owns the asset and grants the right to the other party is known as lessor. There can be different assets that can be provided on lease by the lessor. These involve property, machinery, equipment, and so on. The lease rentals can be monthly or a lump-sum payment can also be made by the lessee. The agreement only confers a right to use the asset to the lessee and it is important to note that the lessor remains the owner of the asset.
Role of Lessor
The lessor is expected to perform the following functions:
- It is required to give possession of the underlying asset to the lessee for its use by the lessee in the conditions and circumstances agreed between the parties.
- It shall ensure that the lessee continues to enjoy the possession of the asset during the lease term as long as payments are being made for the same. There shall not be any disruption in the enjoyment of the lease rights during the lease term.
- If there is any defect in the underlying asset then it shall disclose the same before entering into the lease arrangement. There can be two types of defects namely latent defects and apparent defects. Latent defects are those that can’t be discovered through regular inspection. On the other hand, apparent defects are those that can be easily found by regular inspection.
- The expenses that are incurred by the lessee on the preservation of the leased asset shall be reimbursed by the lessor. However, the regular maintenance and operating expenses are to be met by the lessee.
Types of Lessors
There are typically three kinds of lessors as follows:
- Manufacturer or Vendor: The lessor either manufactures the assets that it leases or is a vendor who has an agreement with the leasing company to provide competitive rates.
- Bank: Banks sometimes own leasing companies and extend leasing offers to their existing customers.
- Independent: These are the lessors that are purely into leasing. They might deal with specific industries or asset classes or may deal generally too.
Examples of Lessors
Suppose a company named RE Properties owns various real estate properties including commercial and residential properties. The company enters into 5 agreements as follows:
|
Property Type |
Lease Term |
Monthly Rentals |
| Residential- 2 agreements | 5 years | $5,000 |
| Commercial- 3 agreements | 10 years | $12,000 |
Here, RE Properties is the lessor that has entered into lease agreements for the properties.
Lessor vs Lessee
In a leasing arrangement, there are two parties, the lessor and the lessee. A lessor is a party that owns the asset and gives a right to use the asset to the lessee. The lessor retains the ownership rights during the lease term and receives periodic lease rentals as agreed with the lessee. At the end of the lease term, the possession of the asset is given back to the lessor unless the lessee exercises the option to purchase the asset against the transfer price.
Lessee is the party that obtains the right to use the asset for a defined period. The lessee is required to make periodic payments to the lessor in the form of lease rentals. The asset remains in the possession of the lessee during the lease term although the lessee doesn’t acquire ownership of the asset under the lease. At the expiry of the lease period, the lessee is required to transfer the possession of the asset back to the lessor.
Advantages
Leasing provides the following benefits to a lessor:
- It gets periodic lease rentals through which not only it can recover the cost of the asset but can earn profits.
- It is eligible to claim tax benefits on account of expenses such as depreciation on assets, maintenance incurred, and so on.
- Ownership lies with the lessor and in case the lessee defaults in payments then the lessor can take back the possession of the asset. Thus, this arrangement is less risky for the lessor.
- The lease rentals are generally high than the installments paid to the financer of the asset which creates a profitable project for the lessor.
Disadvantages
Leasing arrangement has some limitations too for the lessor.
- The lessor bears the risk of the asset becoming obsolete.
- The lessor can’t charge increased lease rentals in a situation where the market value of the asset increases.
- It takes a substantial time to recover the initial cost of the asset.
- In case of unusual market fluctuations, cashflows can get affected and the lessor may not be able to manage its cash flows in the leasing projects.
Conclusion
Leasing arrangements are often preferred by organizations as the same gives them a right to use the asset for a certain period. It is especially preferred when the cost of an asset is high and the acquisition of the asset requires high cash outflow.
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