What is a lease?

The lease is an accounting term for a leased asset. The asset is generally a property such as a building or a space in a building. The lessee concludes with the lessor the right to use the property in exchange for a series of payments provided for during the term of the lease. Renting space in an office building for business use or renting a building for a retail store are two examples of a commercial lease agreement.

Key points to remember

  • A lease is an accounting term that refers to an asset or property that a tenant (tenant) agrees to rent from a lessor (owner) for an agreed period in exchange for planned payments.
  • Retail store owners often use rental agreements for their businesses rather than building their own buildings.
  • Commercial property leases can be complex agreements that stipulate elements such as the payment structure, breach of contract clauses and leasehold improvement clauses.
  • The contract will stipulate which party is responsible for making leasehold improvements, which could include things such as building walls and partitions, adding lighting fixtures or building shelving.

Understanding leases

A rental contract will specify the terms of the agreement between the tenant (tenant) and the lessor (owner or owner). Contracts for commercial properties – like space in an office building – are usually complex agreements that stipulate the responsibilities of the owner, the responsibilities of the tenants, security deposits, breach of contract clauses and leasehold improvement. Larger tenants can request more favorable conditions in exchange for renting more space for a longer period. Leases for commercial properties generally last from one to 10 years.

Rental improvements

After the conclusion of a rental contract, the tenant or lessee begins to build the space for his purposes to the extent permitted by the contract. Work on walls, ceilings, floor space, lighting fixtures, additional plumbing fixtures, shelves and cabinets represent leasehold improvements that are recorded as capital assets on the balance sheet of a business.

Depending on the contract, leasehold improvements can be paid for by the tenant, the landlord, or a combination of the two. Some landlords may agree to pay leasehold improvements to encourage a new tenant to sign a lease. However, when demand is high for a building or office, the owner may not be willing to incur additional expenses for leasehold improvements. Leasehold improvements that are permanently attached to the building often remain the property of the owner, even after the end of the lease.

Leasehold improvements are made inside a building; modifications made to the exterior of a building are not considered to be leasehold improvements.

Example of lease

Leases are the most common for brick and mortar retailers. Best Buy Co., Inc. is one such example. The company rents the majority of its buildings and makes rental improvements that suit its standardized functional and aesthetic interior design. Most of the company’s leases contain renewal options and escalation clauses, as well as contingent rents based on specified percentages of revenue, which is a common term in leases for retailers.

Rental charges are recognized on a straight-line basis until the end of the initial lease term, and any difference between the amounts of the linear charges and the rent payable is recognized as deferred rent. For some retailers, leasehold improvements represent a significant portion of gross tangible capital expenditures.

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