LEASING

LEASING

• It is the process by which a firm

can obtain the use of certain fixed
asset for which it must make a
series of contractual, periodic, tax
deductible payments( lease rentals).
 Definition of lease

• “lease is a contract whereby the owner of an asset

(lessor) grants to another party (lessee) the exclusive

right to use the asset usually for an agreed period of

time in return for the payment of rent”

• James C. Van Horne

 ELEMENTS

• Parties to the contract :

• Lessor- is the owner of the asset that are

being leased

• Lessee- is the receiver of the services of the

asset under a lease contract.
 features
•Assets – property/ equipment

•Ownership separated from user

•Term of lease

•Lease rentals - consideration

• Modes of terminating the lease

 Classification

A. Operating lease(service lease)

-short period, cancelable,
maintenance by lessor
hotel rooms, taxi, houses, godown
etc.

B. Financial lease- long period, non-

cancelable, maintenance lessee
Difference:
• O.L- rental not more than original cost)/
F.L- installment loan.(> original cost)
• O.L – tax, insurance- lessor/F.L – lessee
• O.L- risk of obsolescence by lessor/ F.L
• O.L- contract- short period./ F.L
• O.L – cancellation
• O.L – computers, office equipments,
automobiles, trucks./
• F.L – aircrafts, heavy machinery.
• O.L- Lessor fulfills service function. F.L
– lessor fulfills financial function.
Types of financial leasing:
1. Saleand lease back
2.Direct lease- lessee selects
3. Leveraged lease- financier- 25%
lessor.
Other types of lease
4. Domestic lease and international lease
5. Closed and open ended lease- return
asset
6. Master lease- more than economic life.
7. Percentage lease- % of gross revenue to
the lessor
8.Wet and dry lease- extra expenses also
financing by lessor.
9. Swap leasing – exchange equipment.
Advantages of leasing to the lessee:

• Financing of capital goods

• Additional sources of finance
• Less costly – rent
• Ownership preserved- risk is low
• Tax benefits- lease rentals
• Obsolescence risk is averted
• Avoidance of initial cash outlay
• Advantages of leasing to the lessor:
• Full security
• Tax benefit
• High profitability
• High growth potential
Disadvantages
Restrictions on use of equipment
Limitations of financial lease
Loss of residual value (lessee)
Consequence of default
Cost is high when compared to debt
Legal aspect
• Lessor:- duty to deliver the asset, legally
authorise the lessee to use the asset , and to
leave the asset in peaceful possession of the
lessee during the currency of the agreement
• Bailor.
• Lessee: 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, to return the asset.
Contents of lease agreement

• 1. description of the lessor, lessee and

equipment
• 2. amount, time and place of rental payments.
• 3. time and place of equipment delivery
• 4. lessee’s responsibility for maintenance,
repairs, registration, etc and lessor’s right in
case of default.
• 5. lessee’ responsibility for taking delivery and
possession of the leased equipment.
• 6. lessee’s right to enjoy the benefits of the
warranties provided by the eqpt manufacturer.
• 7. insurance
• 8. changes in lease rent
• 9. option of renewal.
• 10. return
• 11. arbitration
Income tax provision

• lessee – lease rental tax deductible but for

lessor taxed under the head “profits and gains
of business or profession”
• Lessor can claim investment allowance and
depreciation on asset.
• Sales tax : lessor not entitled for concessional
tax rate.
Accounting treatment

 Asset is shown on the balance sheet of the

lessor.
 Depreciation and salvage
 Rent is income in the books of the lessor and
expense in the books of lessee
Problems

• 1. unhealthy competition
• 2. lack of qualified personnel
• 3. tax consideration
• 4. stamp duty
• 5. delayed payment and bad debts
HIRE
PURCHASING
 HIRE PURCHASING

• Hire Purchase is a method of selling goods.

• Goods are let on hire by a finance company
(creditor) to the hire purchase customer (hirer).
• Buyer is required to pay an agreed amount in
periodical installments during a given period.
• The ownership of the property remains with
creditor and passes on to hirer on the payment
of last installment.
FEATURES:
1. Possession immediately
2. Each installment: hire charges
3. Ownership only on payment of last installment.
4. Default – seller reposes
5. Return the goods by terminating but cannot
recover sum paid.
Difference between H.P & Leasing

• 1. ownership.
• 2. method of financing- business asset but both
business assets & consumer articles.
• 3. Depreciation allowance
• 4. tax- lease rent but only interest on
installment
• 5. salvage value
• 6. deposit- 20% deposit
• 7. rent vs purchase
• 8. Extent of finance- 0-25% down payment.
• 9. Maintenance
• 10. reporting- B/S- foot note only.