What is leasing?

In brief, leasing is a financial method used by businesses to obtain equipment or

assets with little capital investment. More often than not, leasing is the preferred
financing option in industry. The concept has been widely used in Russia for
over 10 years now. 

Types Of Leasing

*FINANCE LEASING* - Long-term, non-cancellable lease contracts are

known as financial leases. The essential point of financial lease agreement is
that it contains a condition whereby the lessor agrees to transfer the title for the
asset at the end of the lease period at a nominal cost. At lease it must give an
option to the lessee to purchase the asset he has used at the expiry of the lease.
Under this lease the lessor recovers 90% of the fair value of the asset as lease
rentals and the lease period is 75% of the economic life of the asset.

The lease agreement is irrevocable. Practically all the risks incidental to the
asset ownership and all the benefits arising there from are transferred to the
lessee who bears the cost of maintenance, insurance and repairs. Only title
deeds remain with the lessor. Financial lease is also known as ‘capital lease’.

*OPERATIONAL LEASING* - This lease agreement gives to the lessee only

a limited right to use the asset. The lessor is responsible for the upkeep and
maintenance of the asset. The lessee is not given any uplift to purchase the asset
at the end of the lease period.
Normally the lease is for a short period and even otherwise is revocable at a
short notice.

*LEASEBACK* -It is a sub-part of finance lease. a transaction where an

owner sells an asset and leases it back as a way to secure financing, meaning
that the seller and the lessee are one person. Under this arrangement, the assets
are not physically exchanged but it all happens in records only. The advantage
of this method is that the lessee can satisfy himself completely regarding the
quality of the asset and after
possession of the asset convert the sale into a lease arrangement.

*SUBLEASING* - a transaction that involves leasing out equipment obtained

under a leasing contract. A customer who has leased equipment becomes the
lessor and leases out this equipment to its own customers.

*CrossBorderLeasing*

It is international leasing and is referred otherwise as transactional leasing.

Relates to lease transaction between different a lessor and lessee domiciled in
different countries.

LEGAL ASPECTS OF LEASING:

According to Section 146 of the Indian Contract Act, 1872 Bailment is "the
delivery of goods by one person to another person for some purpose, upon a
contract that they shall, when the purpose is accomplished, be returned or
otherwise disposed of according to the directions of the person delivering
them." The person delivering the goods is called the bailor and the person to
whom they are delivered is called the bailee`

Since an equipment lease transaction falls in the category of a bailment

contract, the obligations of the lessor and the lessee are similar to those of the
bailor and the bailee (unless expressly specified otherwise in the lease
agreement) as given in the Indian Contract Act. Briefly, these may be stated as
follows :

(1) The lessor has the duty to deliver the asset to the lessee, to legally
authorize the lessee to use the asset and to leave the asset in peaceful
possession of the lessee during the lease period.
(2) The lessee has the obligation to pay the lease rentals as specified in
the lease agreement, to protect the lessor's title, to take reasonable care of
the asset.

Tax Implication on lessor and lessee:

1.The lessee can claim lease rentals as tax-deductible expenses.

2. The lease rentals received by the lessor are taxable under the head of
'Profits and Gains of Business or Profession'.
3. The lessor can claim investment allowance (this may be doubtful) and
deprecation on the investment made in leased assets.

ACCOUNTING TREATMENT OF LEASE:

[OPERATING LEASE]

 The Operating Lease are capitalized in the books of Lessor.

 Lease rent treated as income for the lessor while it is an expense
for the lessee
 Depreciation is claimed by the lessor

Financial Lease:
  The finance lease is capitalized on the books of lessee
 The leased asset is depreciated in the books of lessee
 At the time of inception, the leased equipment is shown as asset,
taken on the asset side of balance sheet

Merits of leasing

1. Leasing saves you the trouble of tying up large amounts of capital to buy the
required asset.

 2. Lease payments are distributed in the most convenient way for the lessee, in
sync with the period when the company starts profiting from the leased asset
that is generating a return on investment.

 3. Leasing offers savings through tax preferences (profit tax, VAT deduction,
property tax).

 4. Leasing offers the only possibility to apply accelerated amortization with a
coefficient of up to 3. As a result, the balance-sheet value of property decreases
at 3 times the normal rate, resulting in lower property tax.

 5. The repayment schedule (schedule of lease payments) is highly flexible. The
lessee makes no payments until the leased asset is launched into operation.

 6. The leased asset may be reflected on the balance sheet of either the lessee or
the lessor. In the latter case, the lessee has a chance to improve the structure of
the balance sheet by reflecting the leased asset in off—balance sheet accounts
(this is impossible with credit or direct purchase).

 7. Also, if the leased asset is reflected on the balance sheet of the leasing
company, the lessee has no need to reappraise the fixed assets (in terms of the
leased asset).

 8. At the expiry of the lease contract, the lessee has a chance to receive title to
the leased asset at zero cost.

 9. As a rule, the lease contract is made for 3-5 years, which roughly
corresponds to the payback period of the leased asset. If the leased asset is
equipment with a long payback period, the lease contract may be prolonged to
5-6 years. Far from all lending institutions are prepared to offer such terms.
 10. Securing funding via leasing is much simpler, and collateral is required
much less frequently, because the leasing company will own the asset until the
expiry of the lease contract.

 11. Thanks to its simplicity, affordability and effectiveness, leasing enables

lessees to keep their production assets up to speed with the modern market
requirements, giving them considerable competitive edge.

Differences Between Hire Purchase and Leasing

these methods are not necessarily suitable for every business or for every asset
purchase. There are a number of considerations to be made, as described below:

Certainty

One important advantage is that a hire purchase or leasing agreement is a

medium term funding facility, which cannot be withdrawn, provided the
business makes the payments as they fall due.

The uncertainty that may be associated with alternative funding facilities such
as overdrafts, which are repayable on demand, is removed.

However, it should be borne in mind that both hire purchase and leasing
agreements are long term commitments. It may not be possible, or could prove
costly, to terminate them early.

Budgeting

The regular nature of the hire purchase or lease payments (which are also
usually of fixed amounts as well) helps a business to forecast cash flow. The
business is able to compare the payments with the expected revenue and profits
generated by the use of the asset.

Fixed Rate Finance

In most cases the payments are fixed throughout the hire purchase or lease
agreement, so a business will know at the beginning of the agreement what their
repayments will be. This can be beneficial in times of low, stable or rising
interest rates but may appear expensive if interest rates are falling.

On some agreements, such as those for a longer term, the finance company may
offer the option of variable rate agreements. In such cases, rentals or
installments will vary with current interest rates; hence it may be more difficult
to budget for the level of payment.

The Effect Of Security

Under both hire purchase and leasing, the finance company retains legal
ownership of the equipment, at least until the end of the agreement. This
normally gives the finance company better security than lenders of other types
of loan or overdraft facilities. The finance company may therefore be able to
offer better terms.

The decision to provide finance to a small or medium sized business depends on

that business' credit standing and potential. Because the finance company has
security in the equipment, it could tip the balance in favour of a positive credit
decision.

Maximum Finance

Hire purchase and leasing could provide finance for the entire cost of the
equipment. There may however, be a need to put down a deposit for hire
purchase or to make one or more payments in advance under a lease. It may be
possible for the business to 'trade-in' other assets which they own, as a means of
raising the deposit.

Tax Advantages

Hire purchase and leasing give the business the choice of how to take advantage
of capital allowances.

If the business is profitable, it can claim its own capital allowances through hire
purchase or outright purchase.

If it is not in a tax paying position or pays corporation tax at the small

companies rate, then a lease could be more beneficial to the business. The
leasing company will claim the capital allowances and pass the benefits on to
the business by way of reduced rentals.
CHOOSING BETWEEN HIRE PURCHASE AND LEASING:

For evaluation of leasing and hp option companies need to calculate PV net

cash outflows, and decide the option that involves less net cash outflows.
Thus there are three steps involved in evaluation of leasing and hp.

1. Estimation of post tax cash flows associated with leasing as well as hp

option.
Leasing: post tax cash flows=Post tax lease rental: lease rental (1-tax
rate)
HP: Post tax cash flows=Post-tax interest+ principle amount-tax benefit
on differentiation: I(1-t)-PRt+Dt(t)

2. Calculation of PV of post tax cash associated with leasing as well as HP.

3. Choose the option which has lower PV of cash outflows.