Lease financing

Mrs.S.Kirubadevi,M.Com., M.Phil., PGDCA.,
Assistant Professor1
LEASE FINANCING

MEANING
 Leasing- financing concept – is an arrangement
between two parties, - (the leasing co. or lessor)
and (the user or lessee), whereby the former
arranges to buy capital equipment for the use of
the latter for an agreed period of time in return
for rent.
 The rentals – predetermined – payable at fixed
intervals of time, according to mutual
convenience of both the parties.
 However, Lessor remains the owner of the
equipment over the primary period

Definition:
 Leasing is a contract , where by
 The owner (Lessor) of the Asset(Equipment)
 Transfers the possession / right to use the Asset(Equipment)
to another party (Lessee) usually
 For an agreed period of time in return for the payment of
rent.
-James C. Van Home

Essential Elements of Leasing
Parties to a Lease Contract: Essentially two parties
 Lessor – is the owner of the asset that is being Leased.
 Lessee – is the receiver of the services of the asset under a
Lease contract.
 Lessor and Lessee can be Individual or legally recognized party.
 The lessor is either the asset’s manufacturer or an independent leasing
company
 Lease broker – big ticket Leases use him.
 Major Players in Lease Market:
 Banks- Indian & Foreign /FIs
 subsidiaries of Banks/FIs,
 NBFCs

Essential Elements of Leasing
 Asset – Subject matter of Leasing contract; Automobiles,
Plant & Machinery, Equipments, Land & building, Factory,
a running business, aircraft, Ships, etc.
 Ownership – remains with the Lessor
 Use - of the asset is allowed to the Lessee.
 Lease Term – Primary /secondary Lease Term.
 Lease Rentals – is the consideration for the lease
transaction. So structured to recover the investment cost,
during agreed period.

Mrs.S.Kirubadevi,M.Com., M.Phil., PGDCA., Assistant
6

TYPES OF LEASING
 Finance Lease and Operating Lease
 Sale & Lease back and Direct Lease
 Single Investor Lease and Leveraged Lease
 Domestic Lease and International Lease

Finance Lease
Assistant Professor
9
 Long-term, non-cancellable lease contracts are known
as financial leases.
 To record a lease as a capital lease, the lease must be
noncancelable.
 One or more of four criteria must be met:
1. Transfers ownership to the lessee.
2. Contains a bargain-purchase option.
3. Lease term is equal to or greater than 75 percent of the estimated
economic life of the leased property.
4. The present value of the minimum lease payments (excluding
executor costs) equals or exceeds 90 percent of the fair value of the
leased property.


Features of Financial Service
A Financial Lease is structured to include:
 The Lessee selects the equipment meeting his requirement
 The Lessee negotiates the price, delivery schedule,
installation, warranties, maintenance, etc.
 The Lessee informs the above details and Lessor makes the
payment directly to the Seller(manufacturer /distributor).
 The equipment is directly delivered to the Lessee by seller.
 The Lessee enjoys exclusive and peaceful possession and
use of the equipment.
 Enters in to the Lease agreement with Lessor.
 The Lessor pays the amount directly to
Seller(Manufacturer/supplier).

Operating Lease
Characteristics of an Operating Lease:
 also known as service lease, short-term lease or true
lease.
 The Lease term is significantly less than the economic
life of the equipment.
 The Lessee enjoys the right to terminate the Lease at
short notice without any significant penalty.
 The Lessor usually provides the operating know-how,
suppliers related service, and undertakes the
responsibility of insuring and maintaining (repair and
technical service) the equipment

Differentiation Between Operating lease and Financial lease
Assistant Professor
12
BASIS FinancialLease Operating leasE
Meaning Long-term, non-cancellable lease
contracts are known as financial
leases.
A Lease which is a short term one
and one which does not cover the
useful life on an asset is called an
operating lease.
Form In this type of lease, money is
provide by lessor and the asset is
purchase form outside
The lessor is carrying on business
of leasing and he holds such
assets or is a manufacturer of such
asset leases its asset
Maintenance The lessee undertakes the
maintenance of the asset, paying
insurance premium ect.
In this type of lease, repairs and
maintenance is done by the lessor.
Risk of
Obsolescence
In this types of lease, the lessee
bears the risk obsolescence, so far
as he uses the asset.
In this types of lease, the lessor
bears the risk obsolescence
during the period of the lease.

BASIS FinancialLease Operating leas
Period of
Lease
Period of lease – whole useful
life of asset.
Period of lease – for shot time.
Option to Buy Option to buy for lessee. Period of lease – for shot time.
Accounting
Entries
According to the international
accounting standard-17, an
entery iis made in the balance
sheet of the lessee on both the
side
No entry is made in the balance
sheet of the lassee under this type
of lease, because lease is in the
form of a hired asset

Sale and Lease back
Sale and Lease back:
 The owner(Lessee) of the equipment sells it to a Leasing
company (Lessor).
 The Lessor, leases the equipment back to the Lessee.
 Under this arrangement, the assets are not physically
exchanged but it all happens in records only.
 The seller assumes the role of a lessee and the buyer
assumes the role of a lessor.
 The seller gets the agreed selling price and the buyer gets
the lease rentals.
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.

Direct Lease
 Under direct leasing, a firm acquires the right to use an
asset from the manufacturer directly.
 The ownership of the asset leased out remains with the
manufacturer itself.
 Bipartite Lease – Equipment supplier-cum-Lessor and
Lessee.
 Tripartite Lease (Sales-aid-Lease) – Equipment supplier,
Lessor and Lessee.

Single Investor Lease
• Only two parties – Lessor and Lessee.
• Leasing company (Lessor) funds the entire investment,
having appropriate mix of Equity-cum-Debt.
• Finance raised by the Lessor, is without recourse to the
Lessee.

Leveraged Lease
Leveraged Lease:
 3 parties to the transaction.
 Lessor ( Equity investor)
 Lender
 Lessee.
 The Leasing company (Equity investor)
 buys the equipment, through substantial borrowing, and
 with full recourse to the Lessee and without recourse to it.
 The Lender obtains an assignment of the Lease and a first
mortgage of the equipment.

Domestic Lease and International Lease
20
 When a lease agreement is made between citizen of same
countries, it is called Domestic lease
 When a lease agreement is made between citizen of
different countries, it is called International lease
Assistant Professor

Advantages of Leasing
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 Provides full Finance
 Flexible
 Saves from Recurring cost of finance
 Absence of restrictions
 Tax Benefits
 Increases the capacity to borrow
 Useful in case of fast changing technology
 Faster and Cheaper credit
Assistant Professor

Limitations of Leasing
 No Benefit of Residual Value
 High cost of leaseing
 No benefit of ownership
 Not Flexible
 Disputes

Factors affecting Leasing Decisions
 Availability of cash
 Effect on Borrowing Capacity
 Shifting the Risk of Obsolescence
 Convenient Arrangement
 Less Restrictions on Firm
 Salvage Value
 Tax Benefits
 Leas Expenses

Institutions In the field of Leaseing
 All India Financial Institutions
 Leasing Companies
 Banks
 Financial Companies
 Industrial Groups having Leasing Companies

Difficulties Faced by Leasing Companies in India
 Competition
 Lack of Trained Employees
 Proportion of Debt-Equity not maintained
 Lack of Provision for Depreciation
 Low Investment of Promoters
 Shortage of Funds
 Inefficiency of Management
 Government Attitude

LEASING IN INDIA
 Leasing has grown by leaps and bounds in the eighties but
it is estimated that hardly 1% of the industrial investment in
India is covered by the lease finance, as against 40% in
USA and 30% in UK and 10% in Japan.

DIFFERENCE BETWEEN LEASE FINANCING
AND HIRE PURCHASE
BASIS LEASE FINANCING HIRE PURCHASE
Meaning A lease transaction is a
commercial arrangement,
whereby an equipment
owner or manufacturer conveys
to the equipment user the right
to use the
equipment in return for a rental.
Hire purchase is a type of
instalment credit under which
the hire purchaser agrees to
take the goods on hire at a
stated rental, which is inclusive
of the repayment of principal as
well as interest, with an option to
purchase.
Option to
user
No option is provided to the
lessee (user) to purchase the
goods.
Option is provided to the hirer
(user).
Nature of
expenditur
e
Lease rentals paid by the
lessee are entirely revenue
expenditure of the lessee.
Only interest element included
in the HP instalments is revenue
expenditure by nature.
Componen
ts
Lease rentals comprise of 2
elements (1) finance charge
and (2) capital
HP instalments comprise of 3
elements (1) normal trading
profit (2) finance

Lease financing

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