Presentation On Leasing

Prepared by Group No.7

What is Leasing?
It is an arrangement under which a person acquires the right to make use of an asset without owning it. It allows the economic use of an asset for a certain period of time. The agreement is signed between the owner of the asset called lesser and the user of the asset called lessee. Lesser permits lessee to use the asset on the consideration in the form of periodic payments called lease rentals.

Essential Elements Of Leasing

Parties to the contract - there are two parties to a contract of leasing financing, the lessor and the lessee. Asset- The asset, equipment or property is the subject matter of a contract of lease financing. The asset must, however, be of the lessees choice. Ownership separated from user- the essence of a lease-financing contract is that during the lease tenure, ownership of the asset vests with the lessor and its use is allowed to the lessee. On the expiry of the tenure, the asset reverts to the lessor. Term of lease it is the period for which the agreement of the lease remains in operation. Every lease should have a definite period otherwise it will be legally inoperative.

Major players

Independent leasing companies Other finance companies Manufacturer-lessor Financial institutions In-house lessor Broadly, there are three types of leasing companies in India: 1. The 3 all India financial institutions ICICI IDBI IFCI 2. Commercial Banks 3. NBFCs

Advantages Of Leasing

Method of obtaining 100 percent finance. No margin money is required unlike term loans from bank. Facilitate acquisition of an equipment without the necessary capital outlay. Rental pattern of leases can be tailored to accommodate the cash flow position of lessee, thus making the repayment terms flexible. Off-balance sheet finance Tax planning by lessee less costly Simple to negotiate and administer and dispenses with the complexities of documentation compared to security tied credit such as term loan. Hedge against obsolescence. Lease rentals provides for fixed regular payment, and this fixed element in the contract makes for easy cost control and is readily available for pricing policies. Usually free of restrictive conditions. Ex- no nominee directors

Disadvantages of leasing

Lessee is not the owner no depreciation benefit available.

If non tax paying lessee lease is costly.

In some states lessee has to pay double sales tax- one on the cost of equipment and second on rental.
Consequences Of default- if the lessee defaults in complying with any terms and conditions of the lease contract, the lessor may terminate the lease.

Types of leases

Operating Lease further divided into Domestic lease & International Lease
Capital Lease

Operating Lease

An operating lease is relatively short term in length and is cancelable with proper notice. The present value of lease payments is generally much lower than the actual price of the asset. At the end of the life of the lease, the asset reverts back to the lessor who either offers to sell it to the lessee or lease it to somebody else. The ownership of the asset in an operating lease lies with the lessor with the lessee bearing little or no risk if the asset becomes obsolete. Examples leasing of copying machines, automobiles, etc.. some operating leases are noncancellable like an aircraft on an 8 year lease.

Capital Lease

Most of the leasing done in India is of financial lease type, ranging from 5-7 years. The lessee has to pay an up front payment of the asset known as lease management fee along with the lease rentals which could be monthly or quarterly in nature.A lease is regarded as a capital lease if it meets any one of the following conditions The lease transfers title to the asset to the lessee by the end of the lease period. The lease contains an option to purchase the asset at a bargain price. The lease period is equal to or greater than 75 percent of the estimated economic life of the asset. At the beginning of the lease, the present value of the minimum lease payments equals or exceeds 90 percent of the fair value of the leased property to the lessor. A capital lease cannot usually be cancelled. In many cases, the lessor is not obliged to pay insurance and taxes on the asset, leaving these obligations up to the lessee.

Operating lease is further categorized into: Domestic lease- a lease transaction is classified as domestic if all parties to the agreement , namely, equipment, supplier, lessor and the lessee, are domiciled in the same country.

International lease- if the parties to the lease transaction are domiciled in different countries, it is known as international lease. It is sub- classified into:Import lease- here the lessor and the lessee are domiciled in the same country but the equipment supplier is located in a different country. The lessor imports the asset and leases it to the lessee. Cross-border lease- when the lessor and lessee are domiciled in different countries, the lease is classified as cross-border lease. The domicile of the supplier is immaterial.

The international lease transaction is affected by country risk and currency risk. The country risk arises from the need to structure the lease transaction according to the political and economic climate and a knowledge of the tax and regulatory environment governing them in the foreign country concerned..

An Illustrative Example

Company A wants to acquire a machine. It would cost $ 100,000. Company B is prepared to give it on lease on lease rentals of $ 22.50 per month payable monthly in advance, for 60 months. Let us suppose the deal is to be put through. A will be allowed to negotiate all commercial terms with the supplier including the technical specifications. B would walk in after everything is finalised: B would place its orders in the terms A instructs, and acquire the asset. The asset would be put on lease for 60 months; if the asset is expected to last for more than 5 years, the lessee will be given a convenient renewal option, for, say, next 5 years at a nominal rental. [Alternatively, depending on the regulations prevailing, the lessee could be given an option to buy the asset as a token value.] The lessee has been put virtually in the position of an asset owner - he has the right to use the asset for 5 years, with a power to extend the lease period for another 5 years. The first 5 years are called the primary lease period and the extended period is called the secondary lease period

Accounting treatment for leasing

The effects of leasing an asset on accounting statements will depend on how the lease is categorized by the Internal Revenue Service and by generally accepted accounting principles. Leasing an asset rather than buying it substitutes lease payments as a tax deduction for the payments that the firm would have claimed as tax deductions if it had owned the asset (depreciation and interest expenses on debt). Consequently, the IRS is wary of lease arrangements designed purely to speed up tax deductions. From an accounting standpoint, operating lease expenses are treated as operating expenses and reduce operating income whereas capital lease expenses are treated as equivalent to borrowing and buying the assetcapital expense. With a capital lease , the lessee must report the value of the leased property on the asset side of the balance sheet. The present value of the capital lease expenses is shown on the balance sheet as debt. Depreciation on the leased asset as well as imputed interest expenses are shown as expenses in the income statement.

Appraisal criteria used by lessors

The degree of the appraisal by a leasing company is determined by the cash flow involved. The aim of the appraiser is to seek to confirm the ability of the user to meet the rentals. Amongst the main areas to be explored by lessor during the course of investigation is the quality of the companys management.here the lessor wants to know that those responsible for running the company are properly qualified, have a good record of management and a reasonable degree of management succession within the organization. Lessor looks at the companys record as shown by the audited balance sheets and accounts, etc.. The lessor also takes into account the debt ratio. This is done to ensure that a company is not overstretched through having too much borrowing on too small a capital base. The appraiser also satisfies himself that the prospective lessee has sufficient working capital to support extra sales generated by the new investment. Anticipated residual value of the equipment leased, nature of the industry in which the customer is engaged also constitute important factors.

How is it different from debt financing?

Debt financing is basically money that one borrows to run his business. Debt financing can be divided into two categories, based on the type of loan one is seeking: long term debt financing and short term debt financing. Long Term Debt Financing usually applies to assets a business is purchasing, such as equipment, buildings, land, or machinery. With long term debt financing, the scheduled repayment of the loan and the estimated useful life of the assets extends over more than one year. Short Term Debt Financing usually applies to money needed for the day-to-day operations of the business, such as purchasing inventory, supplies, or paying the wages of employees. Short term financing is referred to as an operating loan or short term loan because scheduled repayment takes place in less than one year. In debt financing you own the asset unlike leasing.

Lease Vs.Hire purchase

Hire-purchase, essentially a British form, entered India during the Colonial era, and thrived as almost the only form of external finance available for commercial vehicles. Leasing, essentially a US-innovation, entered the country significantly in the early 80s, and was propagated as an alternative to traditional modes of industrial finance. Besides, the early motivation (which continues with a number of players even now) of leasing was capital allowances, more significantly the investment allowance, which was not available for transport vehicles.

Barriers To Leasing In India

1. Aggressive stance taken by the tax authority regarding disallowance of depreciation on finance lease 2. Economic downturn which has resulted in Non Performing Assets (NPAs) and closure of the Non Banking Financial Companies (NBFCs).
3. Lack of clarity on the Tax treatment of leasing in India.

Thank You!!!!!