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Leasing
Conceptually a lease may be defined as A contractual arrangement in which a party owning an asset (lessor) Provides the asset for use to another (lessee) For an agreed period of time (lease period) For consideration in form for periodic payments( lease rentals) At the end of the period Lease period, the asset reverts to the lessor unless there is a provision for renewal of contract. Thus leasing is a device for financing the cost of an asset. The lessor does not take recourse to the asset as long as the rentals are regularly paid to him. Advantages of Leasing: To the lessee: 1. Financing of asset up to 100%.There is not need of making any down payment, company is able to start his business straightaway 2. Funds are not blocked of the lessee; the same can be used for some optimum use. 3. Leasing provides finance without with out diluting the ownership or control of the problems unlike equity or debt 4. It is preferable to Institutional Finance as restrictive covenants such as representation in the board, conversion of debt or equity, payment of dividend etc. are absent. 5. Facility to structure the lease rentals according to his business operations and his paying capacity is another major advantage for the lessee. 6. Simplicity of the lease finance arrangement at mutually agreeable terms 7. In a leasing arrangement the risk of obsolescence rests with the lessor and the lessee always has the option of replacing the asset with latest technology 8. By employing Sale and Lease back arrangement, lessee may overcome a financial crisis by immediately arranging financial resources. To the Lessor 1. Lessors interest is fully secured as he is always the owner of the asset and can take repossession of the asset is the lessee defaults. 2. Higher Profitability since rate of return is more than in case of lending business. 3. Leasing business has a high growth potential.

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Disadvantages to lessee: 1. Restrictions on use of leased equipment : for example, lessee would not be permitted to make additions on alterations to suit his needs 2. A financial lease may entail a higher payout obligation , if the equipment is not found useful subsequently and the lessee opts for premature termination of the lease arrangement 3. Lessee mostly never becomes the owner of the asset and is thus deprived of the residual value of the asset 4. Consequences of default may prove costly for the lessee 5. Since leased assets do not form part of lessees assets they do not appear in his balance sheet and thus understates his assets Steps Involved in Leasing Transaction: 1. Lessee has to decide the asset required and select the supplier. He has to decide about the design specifications, the price, warranties, terms of delivery, servicing. 2. The lessee, enters into the leasing agreement with lessor. The lease agreement contains the terms and condition of lease such as: The basic lease period. The timing and amount of periodical rental payment during the period of lease. Details of any option to renew the lease or to purchase the asset at end of lease period. Details regarding payment of cost of maintenance and repairs, taxes, insurance and other expenses. 3 After the lease agreement is signed the lessor contacts the manufacturer and request to supply the asset to the lessee. The lessor makes the payment to manufacturer after the asset has been delivered and accepted by the lessee. Types of Lease The lease agreement can be classified into following categories: 1. Financial Lease: It is a lease, which transfer all risk and reward of ownership of an asset to the lessee by the lessor but not the legal ownership. The lessee selects the assets the equipment, settle the lease rental and lease period and can also go for purchase option, where at the end of lease period, the lessee has the option to buy equipment at a predetermined value. The finance lease may also contain a non- cancellable clause which means that lessor transfers the title to the lessee at the end of the lease period.

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3 The lessee uses the equipment uses exclusively, insures and maintains it. It also bears the risk of obsolescence. Contractual period between lessor and lessee is generally equal to full expected economic life of the equipment, The Financial lease is very popular in India as in other countries like USA, UK, and Japan. High cost equipment such as machinery; diesel generators aircraft, land and building are leased under finance lease. The assets leased are generally of specialised nature. 2. Operating Lease: In this lease, the contractual period between lessor and lessee is less than full expected economic life of the asset. The lease is for a limited period of time may be a month, six month, a year or few years. Normally, the risk of obsolescence is enforced on the lessor who will bear cost of maintenance, insurance and other relevant expenditure. The lease is suitable for (1) computers, copy machines and other office Equipment, vechiles, material handling equipment which are sensitive to obsolescence (2) where the lessee is interested in tiding over temporary problem. 3. Sale and Lease Back: Under this type of lease, a firm which has an asset sells it to the leasing company and gets back on lease. The asset is generally sold at its market value. The firm receives the sale price in cash and gets the right to use the asset during the period of lease. The firm makes periodical payment to the lessor. The title to asset vests with the lessor. Leverage lease is done generally in case of air line industries.

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Leverage Lease: There are three parties to the transaction: (1) Lessor (equity investor), (2) Lender (Bank or FI), (3) Lessee. Under Leverage lease arrangement, the lessor borrows a substantial borrow the purchase price of the asset from the lender which is typically a commercial Bank or financial institution. The lender obtains an assignment of the lease and rentals to be paid by the lessee and insists on first mortgage on asset.

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Cross Border Lease: Cross border lease is also known as international leasing, export leasing, and transnational leasing. It relates to lease transaction between lessor and lessee domiciled in different countries. In other words lessor may be in one country and lessee may in other country. To illustrate, if a leasing company in USA leases machinery to a manufacturer in India.

Distinguish between financial lease and operating lease: 1. In financial lease the lease period is generally for economic life of the asset, therefore in life of the asset there will be one lessee. In operating lease the asset is for a shorter period says a month, six month, a year or few years, therefore there are are many lessees in the life of the lessee. Financial lease is suitable for high cost equipment such as heavy machinery, diesel generators, aircraft, land and building are leased under finance lease. The assets leased are generally of specialised nature. The operating lease is suitable for (1) computers, copy machines and other office Equipment, vechiles, material handling equipment which are sensitive to obsolescence (2) where the lessee is interested in tiding over temporary problem. In financial lease, the risk of obsolescence is assumed by lessee. In operating lease, risk of obsolescence is borne by the lessor. In financial lease contracts are usually non-cancellable, whereas in operating lease contracts are cancellable. In financial lease maintenance cost, insurance are generally borne by the lessor. In operating lease maintenance cost, insurance are generally borne by the lessee. The idea of financial lease is to finance the asset. Operating lease is a true rental concept. Accounting treatment discussed below.

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3. 4. 5. 6. 7.

Contents of Lease Agreement: The lease agreement specifies the legal rights and obligations of the lessor and the lessee. It typically contain terms relating to the following: 1. 2. 3. 4. Description of the lessor, lessee and the equipment. Amount, time place and period of lease rentals. Time and place of equipment delivery. Lessees responsibility for taking and possession of the leased equipment. 5. Lessees responsibility for maintenance, repairs, registration. 6. Lessors right in case of default by the lessee. 7. Insurance to taken by the lessee on behalf of the lessor.

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5 8. Terms and condition with respect to variation in lease rental. 9. Terms and condition with respect to renewal. 10. Arbitration procedure in the event of dispute. Structure of Leasing Industry: First Leasing company of India Ltd. was the first leasing company which commenced the business in the country in 1973 at Madras, followed by 20th Century leasing limited, which commenced its activities from Bombay in 1980.The excellent and solid performance of these companies led others to enter the field. All hire-purchase and investment companies added leasing to the memorandum and article of association as one objective of the company from 1980 onwards. Indian leasing industry has broadly classifieds into following types: 1.Banks: The commercial banks in India under sec 19(1) of the banking regulation Act, 1949 have set up subsidiaries for undertaking leasing activities SBI was first bank to start up subsidiary for leasing business in 1986.Other banks which are involved in financial services are Canbank Financial services, Bank of Baroda Financial services, Bank of India Finnacial services. 2.Financial institutions: The Financial institution such as ICICI, IRBI, IFCI have set up their leasing divisions or subsidary to do leasing business. The shipping credit and Investment company of India offering leasing facilities in foreign currencies for ships, fishing companies and other related equipments to its clients. 3.Company: A few public sector manufacturing companies such as Bharat Electronics Limited, Hindustan Packaging Company Limited, and Electronic Corporation of India Limited started to sell their equipment through leasing. 4.Pure leasing: These companies operate independently without any link or association with a any other organization. First Leasing Company of India Ltd, 20th Century leasing, Grover leasing company fall under this category. Hire Purchase and Finance companies: The companies started prior to 1980 to do hire purchase and finance business especially for vehicles added leasing to their activities during 1980.Sundaram finance Ltd, Nagarjuna Finance Ltd belong to this category. Problem of Leasing: Leasing has great potential in India. However, leasing in India faces serious handicaps which may hampers its growth in future: 1.Competition: With the leasing business becoming more competitive, the margin of profit for lessor has dropped from 4 to 5 percent to present 2.5 to 3

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6 percent. Bank subsidiaries and financial institutions have competitive edge over private sector concerns over cheap source of finance. 2.Lack of Qualified Personnel: Leasing requires qualified and experienced people at the helm of its affairs. Leasing is a specialized business and persons constituting management should have expertise in accounting, finance, legal and decision area. In India concept of leasing is new and growing, required personnels are difficult to get. 3.Stamp Duty: Heavy stamp duty is levied on lease documents. This adds burden of leasing industry. 4. Delayed Payment and Bad debts: The problem of delayed payment of rents and bad debts does not take into consideration this aspect while fixing the rentals at time of lease agreement. These problems would disturb prospects of leasing business.

Evolution of Leasing
Leasing activity was initiated in India in 1973. The first leasing company of India, named First Leasing Company of India Ltd. was set up in that year by Farouk Irani, with industrialist A C Muthia. For several years, this company remained the only company in the country until 20th Century Finance Corporation was set up this was around 1980. By 1981, the trickle started and Shetty Investment and Finance, Jaybharat Credit and Investment, Motor and General Finance, and Sundaram Finance etc. joined the leasing game. The last three names, already involved with hire-purchase of commercial vehicles, were looking for a tax break and leasing seemed to be the ideal choice. The industry entered the third stage in the growth phase in late 1982, when numerous financial institutions and commercial banks either started leasing or announced plans to do so. ICICI, prominent among financial institutions, entered the industry in 1983 giving a boost to the concept of leasing. Thereafter, the trickle soon developed into flood, and leasing became the new gold mine. This was also the time when the profit-performance of the two doyen companies, First Leasing and 20th Century had been made public, which contained all the fascination for many more companies to join the industry. In the meantime, International Finance Corporation announced its decision to open four leasing joint ventures in India. To add to the leasing boom, the Finance Ministry announced strict measures for enlistment of investment companies on stockexchanges, which made many investment companies to turn overnight into leasing companies. As per RBI's records by 31st March, 1986, there were 339 equipment leasing companies in India whose assets leased totaled Rs. 2395.5 million. One can notice the surge in number - from merely 2 in 1980 to 339 in 6 years.

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7 Subsequent swings in the leasing cycle have always been associated with the capital market - whenever the capital markets were more permissive, leasing companies have flocked the market. There has been appreciable entry of first generation entrepreneurs into leasing, and in retrospect it is possible to say that specialised leasing firms have done better than diversified industrial groups opening a leasing division. Another significant phase in the development of Indian leasing was the Dahotre Committee's recommendations based on which the RBI formed guidelines on commercial bank funding to leasing companies. The growth of leasing in India has distinctively been assisted by funding from banks and financial institutions. Banks themselves were allowed to offer leasing facilities much later - in 1994. However, even to date, commercial banking machinery has not been able to gear up to make any remarkable difference to the leasing scenario. The post-liberalisation era has been witnessing the slow but sure increase in foreign investment into Indian leasing. Starting with GE Capital's entry, an increasing number of foreign-owned financial firms and banks are currently engaged or interested in leasing in India. Future prospects of leasing industry: Leasing has great prospects in India in view of the fact that barely less than one percent of industrial investment is so far through leasing, where as in 40 % in USA, 30% in UK and 10 percent in Japan ( computers accounted for 40 percent). Leasing is bound to remain an alternative source of finance to cater the needs of industrial and business houses all over the world. Leasing is bound to remain an alternative source of finance to cater the needs of industrial and business houses all over the world. Leasing has great prospects in India. It is the threshold of a major break through in industrial development due to liberalized economic policy, measures intiated by government. Leasing as a convenient and flexible fiancing option can play a vital role in the process of industrial development. The leasing industry has taken the centre stage with the government and public sector undertakings are looking to industry to finance railway, telecommunication, transport, power and infrastructure sectors. The infrastructure financing is very crucial for economic growth. The government has indicated that it is open to suggestions for reviewing the existing policies. Such conduciveness and willingness to prevent bottlenecks in the area of taxation and other areas will go long in speeding up the growth of industry. Hire purchase: In a hire purchase transaction the goods are let on hire by finance company (creditor) to the hire purchase customer (hirer). The buyer is required to pay an agreed amount in periodical installments during the given

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8 period of time. The ownership remains with the creditor and passes on to hirer on payment of last installment.

Evolution of Hire-purchase
The British concept of hire-purchase has, however, been there in India for more than 6 decades. The first hire-purchase company is believed to be Commercial Credit Corporation, successor to Auto Supply Company. While this company was based in Madras, Motor and General Finance and Installment Supply Company were set up in North India. These companies were set up in the 1920s and 1930s. Development of Hire-purchase took two forms: consumer durables and automobiles. Consumer durables hire-purchase was promoted by the dealers in the respective equipment. Thus, Singer Sewing Machine company, or Murphy radio dealers would provide installment facilities on hire-purchase basis to the customers of their products. The other side developed very fast - hire-purchase of commercial vehicles. The dealers in commercial vehicles as well as pure financing companies sprang up. The value of the asset being good and repossession being easy, this branch of financing activity flourished fast, although until recently, most of automobile financing business was in hands of family-owned businesses.

Leasing and Hire-purchase: A vanishing distinction:

Features of Hire purchase Agreement: 1. In hire purchase, hire purchase customer the takes the possession of goods immediately and agrees to pay hire purchase installments for an agreed period of time. 2. The ownership of goods is passed to the hire purchase customer on payment of last installment. 3. If there is a default in any one installment, the seller is entitled to take the goods back. 4. The hire purchase customer has a right to terminate the agreement at any time before the property passes. Thus he has an option to return the goods in which case he need not pay the installments falling due thereafter. However, he can recover the sums already paid as such sums legally represent hire charge on goods in question. Contents of Hire purchase Agreement: There is no prescribed format for a hire purchase agreement, but it has to be writing signed by the both parties to the agreement.

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9 A hire purchase agreement must contain the following particulars: Description of the Hire purchase customer and creditor. Description of goods in a manner sufficient to identify them. Details of hire purchase installment i.e. number of hire purchase installments, amount , due date of payment. Arbitration procedure in the event of dispute.

1. 2. 3. 4.

Hire Purchase and Credit Sale: Hire purchase is different credit sale, because in credit sale. In credit sale, the ownership in goods is passed the buyer immediately, where as in case of hire purchase it is transferred on payment of last installment. Hire purchase and Lease: Ownership Lease Lessor is the owner and the lessee is entitled to economic use of asset. Lessee never becomes the owner of goods Charged in books of lessor Hire purchase Hire purchase customer becomes the owner on payment of last installment

Depreciatio n Magnitude of Funds Maintenanc e

Tax benefits

Extent

Hire purchase customer is entitled to claim depreciation. Magnitudes of Funds involved Magnitudes of Funds involved are usually large. are comparatively less. In finance lease the lessee Hire purchase customers have bears the cost of maintenance, to bear cost of maintenance. where as in operating lease, lessor bears cost of maintenance Lessor is allowed to claim Hire purchase customer is depreciation and lessee is allowed to claim depreciation allowed to claim tax benefits on and finance charge. Seller rentals and maintenance cost. may claim interest on borrowed funds to acquire the asset for tax purposes. Lease financing is invariably In a hire purchase transaction 100% financing and no payment margin money equal to 20of margin money/ down 25% may be payable and at payment/ deposits are involved. times deposits are collected by finance company repayable after payment of last installment.

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