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

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 Rentals find a place in P/L A/C. O.L- Lessor fulfills service function. F.L lessor fulfills financial function.

Types of financial leasing:

i) Sale

and lease back ii) Direct lease- lessee selects iii) Leveraged lease- financier- 25% lessor.

Other types of lease

C.

Domestic lease and international lease D. Closed and open ended lease- return asset E. Master lease- more than economic life. F. Percentage lease- % of gross revenue to the lessor G. Wet and dry lease- extra expenses also financing by lessor.

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

disadvantage
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 lessors 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. lessees responsibility for maintenance, repairs,

registration, etc and lessors right in case of default. 5. lessee responsibility for taking delivery and possession of the leased equipment.

 6. lessees 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 payt 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 payt 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.