LEASING

Leasing : An Introduction Source of medium-term finance for business Facilitates firms to acquire assets or avail the use of assets Supplements traditional sources of finance Through asset building, contributes to capital formation in an economy Convenient and flexible source of financing Used as a marketing tool by the manufacturers

Concept of Leasing Leasing means obtaining the services of an asset on rent or on hire A lease is a contract by which the legal owner of an asset (lessor) gives the right to use the asset to another person (lessee) for a specified period in return for the payment of rent implying the parting of possession of an asset for a temporary period.

The International Accounting Standards (IAS) No The International Accounting Standards (IAS) No. 17 defines lease as an agreement whereby the lessor conveys to the lessee, in return for a payment or a series of payments, the right to use an asset for an agreed period of time.

Elements of Lease Transaction 1. Lease is a contract. 2. Contract between lessor and lessee. 3. Legal ownership of the asset separated from use of the asset. 4. The use of asset by the lessee is the subject matter of a lease contract. 5. Lease contract is for a specific period. 6. Legal owner of the asset is the lessor. Contd…

7. Lessee is the person in possession of the asset and user of the asset. 8. Lessee pays lease rent to the lessor for using the asset.

Elements of a Lease Contract Lease is a bail transaction Two parties involved – lessor (owner), lessee (user) The asset must exist at the inception of lease as well as at the end of the lease period. lease period-operation of contract of lease Upfront charges are collected from the lessee towards lease management fees, security deposit etc Contd…

Lessee pays lease rent to the lessor for using the asset recovering investment and also returns Residual value of leased asset At the end of lease period, lessee may buy the asset or renew lease contract

Lease vs. Loan Finance Lease Loan finance Lessee is beneficiary Lessor is finance provider Asset involved Ownership with lessor Medium term finance Off balance sheet Tax benefits to lease payments Loan finance Borrower is beneficiary Lender is finance provider Money involved Lien over the asset Long term finance On the balance sheet of borrower Tax benefits on interest and depreciation

Lease vs. Hire Purchase Hire purchase Lease Ownership with hire purchase financier Hirer -depreciation in accounting books Hirer -depreciation claim for income tax Only financial charges are deductible Hirer has buying option at end of term Lease Ownership with lessor Lessee-depreciation in accounting books Lessor-depreciation claim for income tax Lease rent deductible in full No buying option at end of term

Finance Lease According to International Accounting Standard No. 17, a finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset. The lessee selects the equipment, negotiates the price and terms of sale, and fixes a lease financing company to buy the asset. Lessee takes the equipment on lease by entering into a non-cancellable agreement with the lease financing company Contd…

Lessee uses the equipment, and takes care of insurance and maintenance of the asset. Lessee bears the risk of obsolescence or risk of loss or damage of the asset risk of loss or damage to the asset is borne by the lessee. Lease period finance lease is split into primary period and secondary period During the primary period, full recovery of investment is made through the lease rents

Operating Lease Also known as service lease or maintenance lease An operating lease is a contract between the lessor and lessee such that the cost of the asset is not fully recovered from a single lessee. Short duration lease periods and multiple lessees for the asset Risk of obsolescence with the lessor Involves technological skills, ability to maintain and manage fleets of equipment and training of personnel on the part of the lessor

Finance Lease Vs. Operating Lease Financial lease Risk and reward to the lessee 5 to 7 years of lease period non-cancellable contracts Maintenance and repairs, risk of obsolescence is with the lessee. Investment recovered from a single lessee Operating lease Risk and reward to the lessor 1 to 3 years of lease period cancellable contracts Maintenance and repairs, risk of obsolescence is with the lessor. Investment recovered from multiple lessees

Other Types of Lease Full pay out lease – a finance lease for the economic life of the equipment. The lessor recover the original cost with the interest on the investment. ‘Wet lease’ and ‘Dry lease’ – In a ‘wet lease’, the lessor is responsible for control and maintenance of the assets and in dry lease by the lessee. Domestic lease vs. International lease – In domestic lease the lessor and lessee are from same country. On the other hand, if the lessor and lessee are in different countries, it is a international lease. Sale and Lease Back – adopted by Cash-strapped firms i.e. sale of assets to the lease finance company and getting the same assets on lease basis from the leasing company.

Benefits of Leasing 100 per cent financing i.e. margin free financing Flexible according to requirements of the lessee Restrictive provisions absent Quick finance Cost economical when compared to term loans Off-balance sheet financing Access to Capital Risk management in cases of residual risk

Rights and Obligations of lessor Right of ownership of the asset Right to claim depreciation on the leased assets Right to ensures proper utilization of asset Right to receive the lease rental and other payments Right to terminate the contract in case of misuse of leased assets Right to file a suit against the lessee for conversion of assets .

Rights and Obligations of lessee Right to use the asset during the lease period based on leased contract Regularly pay the lease rents Protect the asset by taking insurance policy Return the leased asset to the lessor at the end of the lease period or on early termination of leased contract

Leasing Industry in India Incorporation of First Leasing Company of India Limited (FLCI) in September1973 in Chennai introduced Lease finance. In 1980’s, Twentieth Century leasing Limited, Industrial Reconstruction Bank of India, ICICI also entered the leasing sector In 1984 when 65 leasing companies were floated and it increased to 400 in late 1990’s Leasing companies today in India is around 10 Many companies failed due bogus transactions and RBI’s measures to control them

Conclusion Hiring an asset for use in the business for lease rental . Finance lease and operating lease are two types of popular lease contracts . Cheaper funding option and not a device for tax shelter . In India, the lease contracts are largely finance leases in areas like aircraft leasing business, car leasing business and Infrastructure projects .