Question

1) Define a lease. Identify five key provisions that are likely to be included in a lease agreement.

Answer 1

A lease is a contractual agreement between two parties called as lessor and lessee in which lessee agrees to pay a certain amount annually or monthly or quarterly for a particular period of time in exchange of a right to use an asset belonging to lessor. Lease is of two types, Capital lease and Operating lease. In Capital lease the lessee will record the lease as an asset and alongside a liability for lease in the liability side. The value of asset is depreciated by lessee and every year lease liability is reduced by amount of lease payments.

In simple words we can say that a lease is just another method of financing, the only difference is financing is not necessarily done by a financial institution.

The Key Provisions that are likely to be included in a lease agreement are as follows,

1. Provision related to lease term is defined properly in the agreement.
2. Provisions related to option to purchase asset is at the end of lease term is stated in the agreement.
3. Type of lease , operating or capital is mentioned in the agreement along with the present value of lease payments and fair value.
4. Structure of the lease payment, like when the rental will be due such as beginning of the year or end of the year, quarterly or monthly etc.
5. Statement regarding how the lease would be shown in the financial statements of both the parties. We already know financial reporting is different when lease type is different.