Lessee vs Lessor Under ASC 842: Who Each Party Is and What Each Books
Lessee vs lessor: the lessee pays to use an asset, and the lessor grants that right. ASC 842-10-20 defines both terms. A lessee enters into a contract "to obtain the right to use an underlying asset for a period of time in exchange for consideration." A lessor enters into a contract "to provide" that right.
On the books, the lessee records two items under Subtopic 842-20: a right-of-use asset and a lease liability. The lessor records under Subtopic 842-30. What it records depends on whether the lease is operating, sales-type or direct financing.
Both definitions sit in the ASC 842 glossary of terms. Whether a contract is a lease at all is a separate question under ASC 842-10-15-3. That is covered in what constitutes a lease under ASC 842.
Who is the lessor in a lease agreement?
The lessor is the party that provides the right to use the asset. In an office lease, that is usually the landlord. In an equipment lease, it may be the maker, a dealer or a finance company.
The contract's labels help, but the definitions decide. Ask one question: who gives up the use of the asset, and who pays for it? The party that gives up use for payment is the lessor. The party that pays for use is the lessee.
Both parties classify the lease at the commencement date. ASC 842-10-25-2 sets five tests and applies them to both sides. A lessee that meets any test has a finance lease. A lessor that meets any test generally has a sales-type lease.
There is one lessor exception. Under ASC 842-10-25-3A, a lessor classifies a lease as operating when two things are true. Its payments are variable and do not depend on an index or a rate. And sales-type or direct financing classification would produce a selling loss at commencement.
If no test is met, ASC 842-10-25-3 makes the lessee's lease operating. The lessor then tests for direct financing before it lands on operating.
The two sides do not always land in the same box. Each uses its own inputs, such as its own discount rate and residual assumptions. Deloitte's Roadmap: Leases, section 9.2 makes this point. So do not assume the other party's answer mirrors yours.
Is the lessor the owner of the asset?
Usually, but not always. The ASC 842-10-20 definition turns on who provides the right to use an asset. It does not turn on who holds title. A party can be the lessor of an asset it only leases itself.
The sublease is the standard example. ASC 842-10-20 defines a sublease as a transaction in which an asset "is re-leased by the lessee (or intermediate lessor) to a third party (the sublessee)." The original head lease stays in effect. The original lessee becomes the intermediate lessor: a lessee on the head lease and a lessor on the sublease.
What it books depends on whether it is still the party primarily liable for the rent. If it is not relieved of its primary obligation under the head lease, ASC 842-20-35-14 applies. It continues to account for the head lease and applies lessor accounting to the sublease. If the sublease is a sales-type or direct financing lease, it derecognizes the head-lease right-of-use asset.
In that case, if the head lease is an operating lease, the lessee measures the liability under ASC 842-20-35-1 through 35-2 from the sublease commencement date (ASC 842-20-35-14(c)).
If it is relieved of the primary obligation, ASC 842-20-40-3 treats the head lease as terminated. Deloitte's Roadmap: Leases, section 12.3 sums up the usual case: "A lessee/intermediate lessor should generally account for the head lease and sublease as separate contracts."
Two more sublease rules matter. ASC 842-10-25-6 classifies the sublease by reference to the underlying asset, such as the building, not the right-of-use asset. And under ASC 842-30-35-7, the original lessor keeps accounting for the head lease as it did before.
What does the lessee record under ASC 842?
At the commencement date, ASC 842-20-25-1 requires the lessee to "recognize a right-of-use asset and a lease liability." That applies to finance and operating leases alike. The main exception is the short-term lease election in ASC 842-20-25-2. It is made by class of underlying asset.
ASC 842-20-30-1 measures the lease liability at the present value of the lease payments not yet paid. The right-of-use asset starts from that liability.
ASC 842-20-30-5 adds payments made at or before commencement and initial direct costs. It subtracts lease incentives received. For the formula in detail, see how the lease liability is calculated.
The discount rate is the rate implicit in the lease when it is readily determinable. If not, the lessee uses its incremental borrowing rate. A lessee that is not a public business entity may elect a risk-free rate instead of its incremental borrowing rate. ASC 842-20-30-3 allows that election by class of underlying asset.
After commencement, the two lessee types split in the income statement. A finance lease shows amortization of the right-of-use asset and interest on the liability (ASC 842-20-25-5). An operating lease shows a single lease cost, generally straight-line over the term (ASC 842-20-25-6).
What does the lessor record under ASC 842?
The lessor's entries depend on its type under ASC 842-10-25-2 and 842-10-25-3. The three outcomes look very different on the balance sheet.
- Operating lease. The lessor keeps the asset on its books and measures it under other Topics (ASC 842-30-30-4). It records the lease payments as income, generally straight-line over the term (ASC 842-30-25-11).
- Sales-type lease. The lessor derecognizes the asset. It records a net investment in the lease and any selling profit or loss at commencement (ASC 842-30-25-1).
- Direct financing lease. The lessor also derecognizes the asset and records a net investment. Selling profit is deferred and reduces that net investment rather than being recognized on day one (ASC 842-30-25-7 and 842-30-25-8).
For a sales-type lease, ASC 842-30-30-1 measures the net investment as a lease receivable plus an unguaranteed residual asset. Both are discounted at the rate implicit in the lease. For a direct financing lease, ASC 842-30-30-2 measures the same items reduced by the amount of any selling profit, which ASC 842-30-25-8 defers.
After commencement, ASC 842-30-35-1 adds interest income at a constant rate to the net investment. Payments collected reduce it. The direct financing case, with a worked example, is in direct financing lease accounting for lessors.
Lessee and lessor accounting side by side
This table puts both sides of one contract next to each other. Each cell cites the paragraph it relies on.
| Item | Lessee (Subtopic 842-20) | Lessor (Subtopic 842-30) |
|---|---|---|
| Who the party is | Obtains the right to use an underlying asset for consideration (ASC 842-10-20) | Provides the right to use an underlying asset for consideration (ASC 842-10-20) |
| Classification at commencement | Finance if any test is met, otherwise operating (ASC 842-10-25-2, 842-10-25-3) | Generally sales-type if any test is met; otherwise direct financing or operating (ASC 842-10-25-2, 842-10-25-3). Operating if payments are variable and not based on an index or rate, and sales-type or direct financing classification would produce a selling loss (ASC 842-10-25-3A) |
| Balance sheet at commencement | Right-of-use asset and lease liability (ASC 842-20-25-1) | Operating: keeps the underlying asset (ASC 842-30-30-4). Sales-type or direct financing: derecognizes it and records a net investment (ASC 842-30-25-1, 842-30-25-7) |
| Initial measurement | Liability at present value of unpaid lease payments (ASC 842-20-30-1); asset per ASC 842-20-30-5 | Sales-type: lease receivable plus unguaranteed residual asset at the rate implicit in the lease (ASC 842-30-30-1). Direct financing: the same, reduced by deferred selling profit (ASC 842-30-30-2, 842-30-25-8) |
| Over the lease term | Finance: amortization plus interest (ASC 842-20-25-5). Operating: single straight-line lease cost (ASC 842-20-25-6) | Operating: straight-line lease income (ASC 842-30-25-11). Sales-type or direct financing: interest income on the net investment (ASC 842-30-35-1) |
| When a sublease exists | Not relieved of the head lease: keeps head-lease accounting and is lessor on the sublease; derecognizes the head-lease right-of-use asset if the sublease is sales-type or direct financing (ASC 842-20-35-14). Relieved: head lease terminated (ASC 842-20-40-3) | Original lessor continues to account for the head lease as before (ASC 842-30-35-7) |
A worked example: one office lease on both sets of books
The figures are our own. A landlord leases one floor of its building to a tenant. These are every input the arithmetic uses:
- Lease term: 3 years, no renewal or purchase options
- Payments: $10,000 a year, paid at the end of each year
- Discount rate for the lease (lessee): 6%, assumed
- No payments before commencement, no lease incentives, no initial direct costs
- Both parties conclude operating lease. Three years is not a major part of the building's life, and none of the other tests is met. For the landlord, the direct financing test in ASC 842-10-25-3 is not met either. The building's fair value is not given: the example shows the case where every test fails.
The lessee's liability is $10,000 discounted for one, two and three years at 6%. That is $9,434 + $8,900 + $8,396, or $26,730 after rounding.
| Point in time | Lessee (tenant) | Lessor (landlord) |
|---|---|---|
| Commencement | Right-of-use asset $26,730; lease liability $26,730 | No lease entry; the building stays on the books |
| Year 1 income statement | Single lease cost $10,000 | Lease income $10,000; depreciation on the building continues |
| Year 1 liability roll-forward | $26,730 + interest $1,604 ($26,730 × 6%) − payment $10,000 = $18,334 | Not applicable |
| End of year 1 balance sheet | Lease liability $18,334; right-of-use asset $18,334 | Building at carrying amount, less year 1 depreciation |
Why does the right-of-use asset equal the liability at year end? ASC 842-20-35-3(b) measures it at the liability, adjusted for accrued or prepaid payments, incentives, initial direct costs and impairment. With even payments and none of those items, the adjustments are zero. The $10,000 lease cost splits into $1,604 of accretion and $8,396 of asset reduction.
The landlord's books barely move. The same $10,000 shows as income on one side and as cost on the other. Only the lessee carries a new asset and liability.
For leases between entities under common control, the same definitions apply. See related party leases under ASC 842.
Frequently asked questions
Can one company be both a lessee and a lessor of the same asset?
Yes, through a sublease: the original lessee re-leases the asset to a third party while the head lease stays in effect. If it is not relieved of its primary head-lease obligation, ASC 842-20-35-14 applies: it continues to account for the head lease and applies lessor accounting to the sublease. If the sublease is a sales-type or direct financing lease, it derecognizes the head-lease right-of-use asset. If it is relieved of that obligation, ASC 842-20-40-3 treats the head lease as terminated.
Do the lessee and lessor always classify a lease the same way?
No. Both run the same five tests in ASC 842-10-25-2, but each uses its own inputs, such as its own discount rate and residual assumptions. A lessee can conclude operating while the lessor on the same contract concludes sales-type, or the reverse. Deloitte's Roadmap: Leases discusses this asymmetry in sections 8.3.3.1 and 9.2.
What is a co-lessor?
The Topic 842 glossary defines lessee, lessor and sublease, but it has no entry for co-lessor. Whether each party is a lessor for accounting purposes follows the lessor definition in ASC 842-10-20, applied to the facts of the arrangement.
Sources and further reading
- KPMG Handbook: Leases, which reproduces the Topic 842 glossary, chapter 6 (lessee accounting), chapter 7 (lessor accounting) and chapter 8 (subleases).
- Deloitte Roadmap: Leases, section 8.3, Lease Classification (lessee).
- Deloitte Roadmap: Leases, section 8.4, Recognition and Measurement (lessee).
- Deloitte Roadmap: Leases, section 9.3, Recognition and Measurement (lessor).
- Deloitte Roadmap: Leases, section 12.3, Accounting for a Sublease by the Lessee/Intermediate Lessor.
Tour of iLeasePro
Schedule a Demo
Check Out Knowledge Base
