Lease and its types

Lease
A contract under which one party lessor (owner)
of an asset agrees to grand use of that asset
to another party Lessee in exchange for some
periodic rental payments.
 Characteristics of Lease:

• Ownership do not transfer but asset can be used

• Periodic payment is known as Lease rent
(Treated as revenue expense)
• Assets can be movable and Immovable as well
• Sometime in an agreement lessee can buy& own
lease asset at the end of contract, else it will be
returned
• If price of an asset is continuously increasing
because of inflation still periodic payment will not
change
 Legal Aspects of lease:

The leaser has duty to:

• Deliver asset to lessee
• Authorize lessee to use an asset
• Lease an asset in peaceful possession

The lessee has duty to:

• Pay the lease rental periodically
• Take reasonable care of an asset
• Return the leased asset
 TYPES OF LEASE

1)Operating Lease:
A lease in which all risks and rewards related to asset
ownership remain with the lessor for the leased asset
is called operating lease. In this lease, the asset is
returned by the lessee after using it for lease term
agreed upon.Lessee enjoys a cancellation option
Ownership of the asset remains with the lessor for the
entire lease period.
Accounting treatment: Operating lease is treated
generally like renting. That means, the lease payments
are treated as operating expenses and the asset does
not show on the balance sheet.
 Conti…….
Purchase option: In operating lease, the lessee
does not have any option to buy the asset during
the lease period.
Lease Term: Lease term extends to less than 75% of
the projected useful life of the leased asset.
Expenses Borne: Lessee pays only the monthly
lease payment in operating lease.
Running Cost In operating lease, no running or
administration costs are to be borne for example:
registration, repairs etc. since it gives only right to
use the asset.
 Example
Let's assume Company XYZ needs a widget machine for
its factory. The widget machine costs $1,000,000 to
buy, but Company XYZ could also lease the widget
machine for $2,000 a month instead. This certainly
could preserve a considerable amount of cash for the
company. If Company XYZ enters into an operating
lease for the asset, it also will not assume any of the
risks of ownership by leasing the machine rather than
buying it. However, it will have to record all of the lease
payments on its income statement (thereby reducing
its net income) rather that placing the asset on
its balance sheet and recognizing only depreciation on
the income statement.
 2)Capital Lease/financial lease:

In financial lease (Also known as capital lease), the

risks and rewards related to ownership of asset
leased are transferred to the lessee.Generally,
financial or capital leases cannot be cancelled.
Ownership transfer option at the end of the lease
period is there with the lessee. Title might or
might not be transferred eventually.
Ranges from 3 to 50 year and even more than that.
 Conti…..
Accounting treatment: Financial lease is treated like loan
generally. Here, the asset ownership is considered of
the lessee and so asset appears on the balance sheet.
Purchase option: Financial lease allows the lessee to
have a purchase option at less than the fair market
value of the asset
Lease term is generally more than or equal to estimated
economic life of the asset leased.
Expenses borne: In financial lease, lessee bears
insurance, maintenance and taxes.
Running Cost: In a financial lease, running cost and
administration expenses are higher.
 Example
• the lessee (customer or borrower) will select
an asset (equipment, vehicle, software);
• the lessor (finance company) will purchase that asset;
• the lessee will have use of that asset during the lease;
• the lessee will pay a series of rentals or installments for
the use of that asset;
• the lessor will recover a large part or all of the cost of
the asset plus earn interest from the rentals paid by
the lessee;
• the lessee has the option to acquire ownership of the
asset
 Other Types of Lease

1)Net Lease:
A type of lease in which lessee will bear cost of
maintenance and repair and will insure leased
asset through insurance company.
2)Full Service Lease:
A type of lease in which lessor will bear cost of
maintenance and repair and will insure leased
asset through insurance company.
 Conti….

3)Sale & Lease Back: Occurs when a company

sells an asset it already owns to another firm
and immediately leases it from them.
Two sets of cash flows occur:
– The lessee receives cash today from the sale.
– The lessee agrees to make periodic lease
payments, thereby retaining the use of the asset.
 Conti….
Leverage Lease:
Type of lease in which three parties are involved the
lessee, the lessor, and lenders.
– A lease agreement that is partially financed by the
lessor through a third-party financial institution. In
a leveraged lease, the lending company holds the title
to the leased asset, while the lessor creates
the agreement with the lessee and collects the
payment. The payments are then passed on to the
lender.“This means that the lessor is not obligated to
the lender in case of a default by the lessee”