Leasing and Hire Purchase

Leasing
• Method of acquiring right to use an equipment or asset for a consideration.
• Suitable for financing most investments like -
– agricultural equipments,
– medical equipments,
– construction equipments,
– office equipments,
– machinery, aircraft,
– high-value cars,
– software, green energy and windmills,
– corporate jets,
– telecom towers,
– satellite,
– mining equipments and
– alternate energy
• Deemed as sale under law and sales tax is
levied on the lease rentals.
 Characteristics of lease
• The Parties
• Ownership
• The Asset
• The Term
• The Lease Rentals
• Tax-Benefit
• No. of Lessee
 Types of Lease
• Financial Lease :
• Operating Lease
• Conveyance Type lease
• Leveraged Lease
• Sale and Leaseback
• Partial Pay-Out Lease
• Consumer Leasing
• Balloon Lease
• Close end leasing
• Swap Leasing
• Wrap Leasing
• Import Leasing
• Cross Border leasing
• International Leasing
 Types
• Financial Lease
• Also called Capital Lease‟ A contract involving
payment over an obligatory period, of specified sums
sufficient in total to amortize the capital outlay ,
besides giving some profit to the lessor.
• ICAI defines it as : financial lease is a lease under
which the present value of the minimum lease
payments at the inception of the lease exceeds or is
equal to substantially the whole of the fair value of
the leased asset.”
 Financial Lease
• It is non-cancelable in nature.
• The lessee is responsible for the maintenance
of the asset leased.
• The lease generally provides for the renewal
of the lease on expiry of the lease contract.
Variants : full payout lease , True Lease
• Characteristics of Finance Lease
– Ownership
– Term of Lease
– Monthly Lease Rentals
– Asset
– Processing Time and Fee
– Margin Money
– Collateral Security
 Process
• First of all, lessee selects the equipment or the asset.
• Lessee only negotiates with the manufacturer about the price, features, and
functionality of the assets.
• Lessor purchases it from either the manufacturer or at times from the lessee.
When the lessor purchases an asset from the lessee and leases it back to the
lessee, it is a different leasing arrangement called Sale and Lease Back.
• Post-purchase, lessor leases the asset to the lessee. Lessor retains ownership
while lessee gets the right to use against fixed monthly rentals.
• The capital lease provides the lessee an option to purchase at the end of the
period.
• Originally, a lease is agreed for the non-cancellable period which we call the
primary lease period. During this period, the lessor/investor seeks to recover
his invested money with some profits.
 Operating Lease
• An operating lease is a type of lease whereby
the asset is not fully amortized during the
non-cancelable period of the lease , and
where the lessor does not rely on the lease
rentals for profits.
• Short term lease on a period to period basis.
Period of the lease is less than useful life of
the asset.
• The lease is cancelable at short notice by the
lessee.
• The lessee has the option of renewing the lease
after the expiry of the lease period
• Asset maintenance and insurance etc. is the
responsibility of the lessor and he charges for the
same.
• It is a high risk lease to the lessor, as any time it
may be cancelled by the lessee.
 Net Lease

• A variant of operating lease, where the lessor is

not concerned with the repairs and maintenance
of the leased asset.
• Lessor does not provide:
- repairs, maintenance, servicing of lease property
- purchasing parts and accessories.
- loan of a replacement/substitute
- purchase of insurance for the lessee.
• Conveyance Type Lease :
– Very long type of lease applicable to immovable property.
– Objective to convey the title in property.
– Lease periods as long as 99 to 999 years. Leveraged Lease
– Where a financier is involved for the whole or a part of
the financial requirement.
– Used for high value asset.
– The financier will have charge over the leased asset, over
and above the lease rentals.
 Types of Lease
• Sale and Leaseback:
• Owner of the asset sells it to the lessor, and
gets the asset back under the lease
agreement.
• Ownership transfer from the original owner to
the lessor, who again leases out the asset.
• Immediate financing to the seller company,
whose funds are tied up in the asset.
 Types of Lease
• Leveraged Leasing:
Third party is also involved apart form lessor and lessee
• Partial pay out lease:
Full payment of the lease in several leases.
• Consumer Leasing :
Leasing of consumer durables like Refrigerator, televisions, etc.
• Balloon Lease :
Lease which has zero residual value at the end of the lease period. i.e. low lease rentals at
the inception, high in the mid years, and low again at the end of the lease.
• Close end leasing :
Asset is reverted to the lessor at the end of the lease.
• Open end leasing :
• Lessee guarantees a minimum value to the lessor , from the sale of the asset at the end of
the lease term. If on sale of the asset, the residual value is less , then lessee pays to the lessor
the difference amount.
• Upfront and Back-end Lease:
High lease rentals are charged in the initial years and lower rentals in the later years of
contract and reverse in back-end lease
 Contd…
• Import Leasing :
- leasing of imported capital goods.
- beneficial to the lessee, because arranging
other sources of funds takes long. Lenders do
not usually finance the import duty which forms
sizable portion of the cost.
- during which the prices of imported goods may
rise + fluctuation in exchange rates may happen.
 Contd..
• Cross Border Leasing :
A lease where the lessor is in one country and lessee in
another.
• The Jurisdiction of lessors and lessees are in two different
countries.
– Eg. Leasing of airplanes.
• International Leasing :
A case where the leasing company is operating in various
countries through its branches. International leasing is
active in countries like U.S., Japan, HongKong etc.
 Commonly-used Lease Terminology

• Wet-lease
• Dry Lease
 Advantages
• No Large Outlay
• Tax advantages
• Budgeting
• Hedge against risk of obsolescence
• No coercive covenants
• Inflation-friendly
• Vendor-leasing
 Disadvantages
• No Ownership
• Long-term expense
• Cost of maintenance
• Restrictions on use of equipment
• Consequences of Default
 Financial evaluation
Buy vs. Lease decisions
Sum:
A limited company is interested in acquiring the use of an asset costing
Rs. 5,00,000. It has two options:
(i) To borrow the amount at 18% p.a. repayable in 5 equal installments or
(ii) To take on lease the asset for a period of 5 years at the year end
rentals of Rs. 1,20,000.
The corporate tax is 50% and the depreciation is allowed on w.d.v. at 20%.
The asset will have a salvage of Rs. 1,80,000 at the end of the 5th year.
You are required to advise the company about lease or buy decision. Will
decision change if the firm is allowed to claim investment allowance at
25%?
 Solution

1/1.18
1/(1.18)^2
Solution
Solution when investment allowance is
allowed
Calculaltion of Cash Inflows After Tax
Sum
Solution
Difference between Operating Lease and
Financial Lease
Operating Lease Financial Lease

A lease in which all risks and rewards

related to asset ownership remain with
the lessor for the leased asset is called In a financial lease (also known as a capital
an operating lease. In this type of lease, lease), the risks and rewards related to
the asset is returned by the lessee after ownership of the asset being leased are
using it for the agreed-upon lease term. transferred to the lessee. Read this article
Read more about Operating Lease for in- on Finance Lease for more in-depth
DEFINITION depth coverage. coverage.
The ownership transfer option at the end of
the lease period is available to the lessee.
The ownership of the asset remains with The title may or may not be transferred
OWNERS HIP the lessor for the entire lease period. eventually.
A financial lease is generally treated like
loan. Here, asset ownership is considered
ACCOUNTING by the lessee, so the asset appears on the
EFFECT An operating lease is generally treated like renting.balance
That means the lease payments are treated as operating expenses and the ass
sheet.
In an operating lease, the lessee does not A financial lease allows the lessee to have a
have an option to buy the asset during the purchase option at less than the fair market
P URCHAS E OP TION lease period. value of the asset.
The lease term extends to less than 75%
of the projected useful life of the leased The lease term is generally the substantial
LEAS E TERM asset. economic life of the asset leased.

The lessee pays only the monthly lease
EXP ENS ES BORNE payment in an operating lease.
Since an operating lease is as good as
renting, the lease payment is considered
an expense. No depreciation can be
TAX BENEFIT claimed.
In an operating lease, no running or
administration costs are borne by the
lessee, including registration, repairs etc.,
since this lease gives only the right to use
RUNNING COS T the asset.
Projectors, Computers, Laptops, Coffee
EXAMP LE Dispensers, etc.
In a financial lease, the lessee bears the
cost of insurance, maintenance, and taxes.
The lessee can claim both interest
and depreciation, as a financial lease is
treated as a loan.
In a financial lease, running costs and
administration expenses are higher and are
born by the lessee.
Plant and Machinery, Land, Office Building,
etc.
Difference between operating and financial
lease
Accounting Treatment for Leasing
In the balance sheet the cost price, excluding interest is shown.
Net book value is cost price less provision for depreciation.
In the profit and loss account the interest for the year is shown together with
any depreciation.
In the balance sheet the liability for future lease payments is shown according
to current and long term liabilities. The interest due is not shown as a liability.
 Accounting for Lease (Books of Lessee)
• Financial Lease:
– Shown as liabilities (future lease-rentals payable) as
well assets –’ fixed assets’ in balance sheet at
present value of the committed lease rental.
– Lessee entitled for depreciate the assets in the books
of accounts
– Lease rental-shown as financial charges in ‘P&L
account’
– Principal amount will be deducted from liability of
the lease payable.
 Contd…
• Operating Lease:
– Treated as expense and will be shown in P&L
Account
 Accounting for Lease (in books of Lessor)

• Financial Lease
– Leased asset shown as receivable at net investment
value
– Lease payment receivable will be treated as a
repayment of principal.
• Operating Lease
– Asset: Balanced sheet –fixed assets, depreciation
charged as we depreciation policy
– Lease rentals received as income- P&L account as
income
 Regulatory framework of leasing
• Provisions under Contract Act relating to
Bailment:
• Two parties - lessor - bailor, lessee- bailee.
• Transfer of possession of goods from
bailor(lessor) to bailee(lessee), for a specific
purpose.
• As under bailment, on accomplishment of
purpose the goods transferred from lessee to
lessor.
 Regulatory framework of leasing..
• Liabilities of Lessee(Bailee)..
• Reasonable Care :
• The lessee to take reasonable care of the asset. If he
fails he is liable to for loss or damage to the goods
that he has caused.
• If goods damaged despite of reasonable care,
(floods, riots etc), then the lessee is not responsible.
• Generally lease agreements make the lessee
responsible , irrespective of lessee’s negligence.
 Regulatory framework of leasing.
• Unauthorized Use not Permitted to the Lessee:
• The lessee is not allowed to use the leased asset , for any
purpose other than one specified in the lease agreement.
• If he does so , then the lease agreement is terminated,
and lessor recovers the possession of the goods. Return of
Goods :
• The lessee has to return the goods : on completion of the
lease term; or  the lease agreement has been terminated
by the lessee or lessor/or automatic termination of the
agreement because of breach of conditions.
 Essential elements
• Parties to contract
• Asset
• Ownership separated from user
• Terms of lease
• Lease rentals
• Mode of Terminating Lease
 Lease Structure
• Contract between 2 parties:
• Tangible assets are generally leased. Nowadays
software is also leased.
• Contract for specific time period
• Lease rental (stepped-up and stepped-down)
– Financial lease: principal repayment and interest
– Operating lease: interest on principal, service
charges, depreciation charges, repairs and
maintenance and insurance
 Rights, obligations and responsibilities of
Lessor
• Acquiring the lease asset according to the lessee’s specification
• Right of ownership of the leased asset
• Claim depreciation on the asset
• Ensure the asset is put to fair use and within the limitations
contained in the agreement.
• Sue in case of asset by the lessee.
• Reimbursement of damages in case of misuse of leased assets.
• Recovery of leased asset in the event of the lesse’s failure to
pay the lease rentals or bankruptcy
 Rights, obligations and responsibilities of
Lessor
• Pay lease rental periodically as per lease
agreement
• Keep asset insured at all times for an amount.
• Return the leased asset to the lessor upon
expiration or termination of agreement
• Use and operate during the lease period
• Terminate the financial lease contract, if asset has
not been delivered in line with the contract
• Pay for damages caused by using the lease asset
Difference between Leasing and Hire
Purchase
 Hire Purchase
•Meaning:
Is a peculiar type of transaction in which goods are let on hire with an option to
purchase them.
• Other details:
The hirer has the right to use the asset after payment of a deposit and in return for
making regular payments over an interval of time. These are to cover the cost and
interest. At the end of the period ownership will usually pass from the finance company
to the business.
The asset is shown as a fixed asset since the hirer has sole use of the asset and as long
as payments are made the item can be treated as if the business owns the asset.
In legal terms the business does not own the asset until it exercises the right to
purchase.
 Features
• Hire purchase is based on an agreement in writing.
• The buyer takes possession of the goods at the
time of entering into contract.
• Each installment is treated as hire charges.
• Ownership transfer from buyer to seller on the
payment of last installment.
• The purchaser has the right to terminate the
agreement any time before the property passes.
 Hire Purchase Agreement
• Hire purchase has to be in writing and signed
by both parties.
• The agreement must contain:
– Description of the goods
– Hire purchase price of the goods.
– The date of commencement of the agreement.
– The number of installments, amount and due
date.
 Terms used
• Hire purchaser : A hire purchaser is a person who possess the goods under
hire purchase agreement.
• Hire vendor: Is a person who sells the goods under hire purchase
agreement.
• Cash price: It is the price of the goods which is sold under contract of sale.
• Hire purchase price: It is the price at which goods are sold under hire
purchase system. It includes cash price of the goods and interest.
• Installment money: It is the part of hire purchase price paid by the hire
purchaser in periodic intervals.
• Down payment: It is the initial payment made by the hire purchaser to the
hire vendor at the time of entering in to hire purchase agreement.
• Hire charge: It refers to the difference between hire purchase price and
cash price
 Modus operandi
• Finance /hire purchase company purchases
equipment from equipment supplier and hires
it to hirer after making down payment of 20-
25% of the cost and remaining in EMIs (spread
over 36-48 months)
• Interest is computed on flat rate of interest
and effective rate of interest is applied to
declining balance of the original loan amount
 Three party modus operandi
• Dealer contracts finance company to finance hire-purchase deals submitted
• Customer selects goods and expresses desire to acquire them. Details of
goods are mentioned in document (printed by financer)
• Customer makes down-payment on completing proposal form
• Dealer sends documents to finance company requesting him to purchase
good and accept the hire-purchase transactions.
• Finance company,if accepts signs the agreement and sends a copy to the
hirer, along with instructions for installments.
• Dealer delivers to the hirer and property in good passes to the finance
company
• Hirer pays installment periodically
• On payment of last installment the property in good passes to hirer after
issue of completion certificate by the finance company.
 Rights of the hirer
• Right of protection: It is not possible for a hire vendor to terminate the hire purchase
agreement on account of default in payment of hire charges by the hirer or due to
unauthorised act , Unless the hirer gives notice in writing to the hirer in this regard.
• Right of Notice: When the hire charge are weekly, or a period less than that, one week
notice is to be given, and in all other cases a two week notice is to be given.
• Right of repossession : The right of repossession is not available to the hire vendor
unless sanctioned by the court in the following cases;
– One half of the price has been paid where the hire purchase price is less than Rs. 15000 ( Rs
5000 in case of motor vehicles)
– Three fourth of the price has been paid where the hire purchase price is not less than Rs
15000(Rs 5000 in case of motor vehicle).
– Three fourth or such higher proportion , not exceeding nine tenth where the hire purchase price
is not less than Rs 15000.
• Right to excess amount: The hirer has the right to obtain any amount in excess of the
value of goods repossessed , over and above the amount of installments payable by
the hirer , in the event of a default.
 Hirer’s obligation
• To pay the hire installments.
• To take reasonable care of the goods ( if the hirer
damages the goods by using them in a non standard
way, he or she must continue to pay installment and , if
appropriate ,compensate the owner for any loss in
asset value)
• To inform the owner where the goods will be kept.
• A hirer can sell the products if, and only if, he has
purchased the goods finally or else not to any other
third party.
 Problems of hire purchasing companies in
India
• Legal Restrictions.
• Competitions.
• Bankruptcy.
• No separate legislations.
• Poor government support.
• Diminishing tendency of price.
 Accounting Treatment for Hire Purchase

The cost of the fixed asset is shown in the balance sheet. The cost shown excludes any
interest paid.
The net book value is the cost less any provision for depreciation.
In the profit and loss account the interest paid during the year is shown, together with
any depreciation.
In the balance sheet, the liability for future payments is shown. The liability does not
include interest. The short term and long term liabilities are shown separately.
 In books of hirer
• Cash purchase price of the asset is capitalised
and capital content of the hire-purchase
installment is recorded as liability
 Taxation treatment
• Income tax
– Hirer: Tax shield on depreciation and and also on
finance charges
– Hire Vendor: Liable for tax under head of profit
and gains of business and profession
• Sales tax:
– Hire purchase or sale
 Sum
• Nidhi finance offers a hire-purchase proposal
to one of its customers, Synthetic Chemicals,
which requires an equipment costing Rs. 1
million, on the following terms: (i) a flat
interest rate of 14% and (ii) a hire-purchase
period of 36 months.
 Solution
• Total interest burden = Rs. 1 million (0.14) (3) = Rs. 420,000
• Monthly hire-purchase instalments= (1 million+Rs. 420,000)/36
= Rs. 39,444
• Allocation of Rs. 420,000 over three years as per sum of digits
method
– 1 st year = 36+35+34+……+25/36+35+34+….+1
= 366/666
– 2nd year = 24+23+22+…..+13/(36+35+34+…..1)
= 222/666
– 3rd year = 78/666
Annual hire-purchase instalment would be :
(Rs. 1 million+Rs. 420,000)/3 = Rs. 473,333
 Contd…
• 1st year =366/666*420,000 = Rs. 230,811
• 2nd year = 140,000
• 3rd year = 49,189
• Hire purchase instalments and interest
allocations would be split as follows:
Year Hire Purchase Interest Principal
Installments repayment
1 473,333 230,811 242,522
2 473,333 140,000 333,333
3 473,333 49,189 424,144
 Sum-1
• Cash Price = Rs. 37230
• Down Payment = Rs. 10,000
• Annual Instalments= 3 of Rs. 10,000 each
• Rate of interest= 5% pa
Solution
 Sum-2: When Cash Price, down payment and
instalments are given but rate of interest not given
Contd…
 When down payment, instalments and rate of
interest are given but Cash Price is not given
• Down payment = Rs. 10,000
• Annual Instalments = I yr. Rs. 13,000, II yr. Rs.
12,000 and III yr. Rs. 11,000. Rate of Interest –
10% p.a.
• Solution: In this question interest and principal
component of each instalment shall be
calculated starting from last year. Balance at the
end of each year includes O/S Cash Price and
Interest.
Contd…
 When Cash Price, down payment, instalments
(excluding interest) and rate of interest are given
• Cash Price = Rs. 50,000
• Down payment – Rs. 20,000 and balance payable
in 3 equal annual instalments plus interest.
• Rate of Interest – 9 % p.a.
• Solution:
• Annual Instalment = 30,000/ 3 = 10,000 plus
interest In this question interest shall be
calculated every year and shall be added to
10,000 to find total amount of instalment paid.
 Annuity Method when Instalments are equal When down
payment, instalments and rate of interest are given. Cash Price
not given.

• Down payment = Rs. 15,000

• Annual Instalments = 3 of Rs. 15,000 each
• Rate of Interest – 5% pa.
• Solution: Total Cash Price = Down payment +
(Annual Instalment × Present Value of Re. 1
annuity for 3 yrs at 5% interest)
= 15,000 + (15,000 X 2.723) = 15,000 + 40,845
= 55,845
Contd…
 Annuity Method when Instalments are unequal When down
payment, instalments and rate of interest are given. Cash Price
not given.

• Down payment = Rs. 4,650 Annual

Instalments = I yr – Rs. 7,130, II yr – Rs. 9,020
and III yr – Rs. 4,200.  Rate of Interest – 5%
pa
 Solution
• Total Cash Price = Down payment + Ist
Instalment × Present Value of annuity for 1 yr
at 5% + 2nd Instalment × Present Value of
annuity for 2 yrs at 5% + 3rd Instalment ×
Present Value of annuity for 3 yrs at 5%
= 7,000 + (8,900X 0.952) + (6,500 X 0.907 ) +
(4,200 X 0.864) = 7,000 + 8,473 + 5,896 + 3629 =
24,998
Contd…
 Instalment Purchase
• Is a credit sale in which seller gives the facility to
the buyer to pay the money in agreed instalments.
• Possession and ownership are passed to the buyer
immediately
• Essentials:
– Buyer gets possession and ownership of goods
– Payment of price is made in instalments
– In event of default by buyer, the seller can sue the buyer
for recovery of the balance of payment
 Hire Purchase v/s Instalment Method
Basis Hire-Purchase
Transfer of ownership Ownership transferred
after payment of all
instalments
Recovery of goods If buyer fails to make
payment of instalment, the
seller can recover the
goods back
Forfeiture of Instalment In case of buyer’s default,
the seller can forfeit all the
money paid by buyer as
rent for using the asset
Instalment Purchase
Ownership immediately
passed at time of sale
If buyer fails to make
payment of instalment, the
seller cannot recover the
goods back
Seller can sue only for the
balance that is not paid.
Thank You