Lease Term

Publication Date :

04 Feb, 2025

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Table Of Contents

Lease Term Definition

The lease term refers to the period during which the lessee cannot terminate the contract. It is the agreed-upon duration for leasing an asset from the lessor, whether it involves equipment or property. It provides temporary ownership of an asset to the lessee as outlined in the agreement concerning responsibilities, payment and use.

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It is used in vehicle leases, equipment leasing, and real estate rentals, providing access to assets while managing risks and costs. Both individuals and businesses benefit from leasing, as it allows them to save on the upfront cost of buying assets and to upgrade to new ones at the end of the lease duration.

Key Takeaways

The lease term depicts the duration of a contract where the lessee cannot terminate the lease agreement that provides temporary ownership of an asset.
It has common terms of lease, including lease maintenance responsibilities, renewal options, termination clauses, late penalty payment for late payments, duration, periodic rent payments, security deposit, and grace payment period.
Its considerations include exploring early termination options, evaluating under accounting procedures, signing agreements, and determining renewal and initial periods.
Its importance lies in defining asset usage duration, liabilities, rent payments, and costs. Moreover, it affects the company’s balance sheet and financial reporting, as well as future lease negotiations and renewal options.

Lease Term Explained

The lease term represents the non-cancellable duration when a lessor provides an asset on lease to the lessee as per agreement. It comprises the time covered for leasing extensions or terminations under options coverage, even if the lessee is unsure of exercising them.

It has become vital in determining the extent and monetary liabilities within a lease agreement. It consists of assessing the lessee's probability of canceling or extending the lease as per contractual terms and economic benefits. The exact ascertaining of the lease term impacts the financial statements, depreciation, and recognition of income from the lease. It also affects the lessee's financial commitments and the lessor's revenue.

It has been significant in the accounting and financial reporting of the parties involved. Both the lessor and lessee use it to correctly represent the financial impact and lease's duration. Furthermore, it significantly impacts the financial world by influencing decisions related to financial planning, investment, and asset management due to its effect on financial statements.

Common Lease Terms

Every lease, including commercial lease terms, includes the following common terms:

Lease duration consists of the time for which the lease agreement remains effective.
The rent amount that the lessee has to pay periodically in exchange for using the asset or property must be mentioned.
The lessee must pay a security deposit to manage any damage to property or payments missed during the leased tenure.
Maintenance responsibilities of the asset or property by the lessor and lessee must be specified clearly.
A renewal option clause must be included in the agreement. This clause allows for the extension of the lease under predetermined conditions.
A termination clause must be included, defining the conditions and procedures for ending the term before its expiry or by any party involved.
It also must outline the amount of late penalty payment when a lessee fails to pay the rent on time and after a certain grace period as per agreement.

Lease Term Considerations

There are certain considerations to be made in terms of the lease, as listed below:

The lease begins when the parties sign the lease agreements to when the lessee has taken possession of the assets.
It must contain any renewal periods and initial lease periods that are certain to be exercised.
It must explore the option to terminate the lease early if the lessee certainly would exercise them.
It must be evaluated under standard accounting procedures like ASC 842 and IFRS, as it can impact financial reporting.
It assesses the classification of the lease because it affects whether the lease has to be categorized as a finance lease or an operating lease.

Examples

Let us use a few examples to understand the topic.

Example # 1

Let us assume that Smith of Old York City owns a car rental firm named Your-Rental Cars Limited. The company offers cars for rent under a Tesla lease term, which includes a short lease term and a 36-month lease at a monthly payment of $500. Additionally, there is a mileage limit of 15,000 miles per annum. At the end of the lease, customers have the option to buy the car for $20,000.

However, if the lessee exceeds the mileage limit, they must pay $0.30 per extra mile. As the lease ends, the lessee can choose to either return or extend the car lease or purchase the leased car. Additionally, there is an option to terminate the agreement early for a fee of $1,000.

Example # 2

An online article published on 27 August 2024 discusses how the retirement village Seasons Caloundra in Queensland is transitioning to a rental-only model. This change is significantly affecting the elderly residents. As a result of the transformation, long-duration leases, such as 99-year contracts, have ended, and services such as laundry, emergency call facilities, and in-house food have been shut down. The retirement home that was built in World War 2 may now evict its nurses and all the residents, posing emotional trauma.

However, before the transformation came into effect, it notified the residents through a 22-page notice, giving options such as signing a 2-year lease for $350 every week or going to other such facilities. After the Department of Housing learned about the case, an investigation started. Furthermore, advocacy groups have started calling for the safety of retirement village residents to be ensured.

Importance

It has various benefits that highlight its importance as below:

Defines the duration of the right to use any asset for the lessee.
Gives clarity on the liabilities of both the lessee and lessor, decreasing the dispute risks.
Properly times the rent payment and other miscellaneous lease-concerning costs.
Influences a company’s balance sheet as it impacts financial reporting and lease classification.
Helps in planning for future lease bargaining and handling renewal options.