What is Lease:
A contract under which one party, the
Lessor (owner) of an asset agrees to grant
the use of that asset to another, The Lessee
(user), in exchange for periodic rental
payment. It is a contractual agreement
between the two parties whereby one
acquires the right to use the property and
the other who allows the former the right to
use his owned property.
Types of Lease:
Essentially there are two types of leasing:
(a) Equipment Leasing; (b) Real Estate
Financing;
Equipment Leasing are two types:
(a) Financial Lease (also called lease
financing); (b) Operating Lease (also
called Service or Non-pay-out lease)
Financial Lease is two types:
(a) Primary Lease; (b) Secondary Lease;
Operating Lease is two types:
(a) Simple operating lease; (b) specialized
Service Operating Lease;
Different between lease finance and hire
purchase:
The main points of distinctions between
finance and hire purchase are as follows:
1) In a lease finance property in the goods
owner transfers the right to use the
property to another party for a period of
time in return of periodic payments.
Whereas in hire purchase the property in
the goods passes to the hirer upon payment
of the last installment.
2) In lease finance a contract under which
one party, The Lessor (Owner) of an asset
agrees to grant the use of that asset to
another, The Lessee (user), in exchange for
periodic rental payment. But in hire
purchase the position of the hirer is that of
a bailee till he pays the last installment.
3) In a lease finance, It is a contractual
agreement between the two parties
whereby one acquires the right to use the
property and the other who allows the
former the right to use his owned property.
But in case of hire purchase, the hirer may,
if he so likes, terminate the contract by
returning the goods to its owner without
any liability to pay the remaining
installments.
Importance of Leasing for developing
country:
In the case of a developing country, lease
from is beneficial for importing equipment
like Ships, aircrafts etc. instead of
borrowing. This will protect a better image
of a nation than a borrower with no
pressing service charges for unpaid loans.
Government should make favorable laws
so as encourage availability of lease
finance for importing plant, machinery and
equipment by the private sector companies
to accelerate the pace of industrialization
and self-reliance in production of capital
goods.
Illustrate the basic characteristics of
Lease:
1) A contract of commercial nature
between the lessor (owner) and the
lessee (user);
2) The contract should provide for
periodical payment of rentals for using
the asset for a fixed term by the lessee;
3) On the expiry of the lease term the
lease should return the asset to the
owner or dispose it in the manner
desired by the owner.
4) Generally two parties are involved
in a lease agreement, they are- a)
Lessor; b) Lessee;
Discuss the characteristics of capital
lease:
A capital lease would be considered a
purchased asset for accounting
purposes. A lease considered to have
the economic characteristics of asset
ownership. A lease falls into capital
lease category if any of the following
requirements are met:
1. The life of the lease is 75% or
greater of the assets useful life.
2. The lease contains a purchase
agreement for less than market value.
3. The lessee gains ownership at the
end of the lease period.
What is Finance Lease:
A finance lease also referred to as a
lease or business lease, it amy suit
those businesses who wish to have an
off Balance Sheet style of funding.
Lessee (user) are not the owner of the
goods so the value of the goods will
not be entered on his/her balance sheet
so neither the contingent liability.
Key Features of a Finance Lease:
1. Flexible Terms: Lease can choose
from terms of 1-5 years.
2. Fixed Residual: A residual may be
compulsory, this residual is set by the
lease provider.
3. Repayment Options: Lessee can
choose to structure a repayment
schedule that suits. This could be
monthly, quarterly or Yearly.
What is Operating Lease:
An operating lease is a lease whose
term is short compared to the useful
life of the asset or piece of equipment
being leased. An operating lease is
commonly used to acquire equipment
on a relatively short-term basis.
Features/Advantages of Operating
Lease:
1. No incidence of the rents on the
balance sheet; they are operating
expenses deductible from profits.
2. Improvement of cash-flow.
3. Economy of corporate taxes.
State the advantage and
disadvantage of lease:
Favorable aspects of lease finacing:
Lessee’s perspective:
(1) Full extent financing of the cost of
capital goods;
(2) Flexibility in payment of lease
rentals;
(3) Favorable duration of lease period;
(4) Medium term finance;
(5) Piecemeal financing device.
(6) Keeping working capital free
(7) Lease as a revenue expenses
(8) Procedural convenience
Lessor’s perspective:
1. Better security;
2. Tax planning;
3. More profitable;
4. High return on equity;
5. No entry barriers.
6. Facility in accession public deposits
Unfavorable aspect of lease finacing:
Disadvantages of Lessee/Lessor:
1. Deprivation of equipment
2. Consequences of default
3. Inadequate protection against loss
4. Loss of terminal value
5. High interest cost
6. Loss of residual value
7. Lack of freedom to make changes
Risks associated with leasing:
The following risks are associated with
lease:
(1) Default risk. (2) Credit risk (3) Risk
changing taxation law (4) Risk of
bankruptcy (5) Acceleration of rents
and other due amounts (6) Risk of
residual value (7) Risk of war, physical
damage of asset etc.
Explain the economics of lease.
The economics of leasing is determined
by considering the time value of money
for the cash flows for leasing vs.
buying an asset.
The Determining Factors
Cash flows: What are the cash flows
related to leasing or buying an asset
and when do those cash flows occur?
Discount rate: What discount rate
should be used to discount the cash
flows to the present to arrive at the net
present value
Discuss the importance of lease as a
source of finance.