Leasing or Lease Financing is one of the most important and most flexible financial

service.

A Lease is a contractual arrangement or transaction between two or more

parties, in which one party owning an asset or equipment (les- sor) provides an
asset to another party (lessee) for use or transfers the right to use the asset,
over a certain or agreed period of time for consideration in form of periodic
payment (rentals) with or without charging a premium. At the end of the
period (lease period) the asset or equip reverts back to the lessor

Lease Financing
Lease Financing or Leasing is a process where one party (lessor) transfers
the right of economic use of an asset to another party (les- see).

Lease Financing essentially involves the divorce of ownership from the

economic use of the asset for the lessor i.e. The Lessor is the owner of
the capital asset and the ownership of the asset always remains with him,
but the right to use the asset is transferred to the lessee. Lessee is the
party who takes the asset or equipment for a specified period and has to
pay lease rentals throughout the lease period.

Leasing or Lease Financing is generally used to finance fixed asset

having high value.

Advantages of Lease Financing

• It helps is reducing the financial burden on lessee.
• It is a device of financing the cost of an asset.
• It is an important financial service as it provides benefit to both
parties.
Types of Lease – Leasing
There are various types of lease as shown in the diagram below

(i) Financial Lease or Capital Lease –

A financial Lease involves payment of lease rentals over one obliga-

tory, non-cancelable lease period sufficient in total to amortize the
capital invested by the lessor and also leave some profit. It involves
the transfer of all risks and rewards associated with the ownership of
the asset to the lessee, but the title of ownership may or may not be
transferred after the completion of lease period. Financial Lease may
be of two types:

Full pay out lease – A Full Payout Lease covers the total
value/cost of the asset through Lease rentals and scrap value. The
lease period usually covers the entire economic life of the asset.

True lease – A true lease only involves only taxation benefits for
the lessor as he bears all the risks and rewards associated with
owner- ship of asset and the lessee only gets the right to use the
asset.

Eg. Ships, air crafts, railway wagon, land, heavy machinery.

(ii) Operating Lease

An Operating lease has the following features:

• It does not transfer all the risks and rewards associated

with ownership of the asset
• The cost of asset is not fully amortized during the primary
lease period
• It consists of a cancellation clause
• Responsibility of maintenance and repair, insurance lies
with the lessor
• The asset is provided on lease for a short period only,
usually less than the useful life of the asset
• It is a high risk lease
• The Lease can be renewed after the expiry of term period

Eg. computer operator, taxi, printers.

Difference Between Operating Lease and

Financial Lease:
Operating Lease Financing Lease
More than one lease
 A single lessee is
The number of contract is undertaken
contracted under a
lease contracts and there are several
single agreement
lessees

The cost of asset is not Fully pay out lease –

fully amortized The asset is
Amortization of because the asset is amortized through a
cost of asset leased many times single lease as it is
with different lessees provided for a long
over a period of time term
Equipment or asset is Asset is for the
Specific Use for general purpose specific use of the
use lessee
Risk associated with
It is transferred to
ownership is borne by
the lessee and the
Ownership risk the lessor and the
lessor only retains
lessee only gets the
the title of ownership
right to use the asset
Undertaken for a short Long time, entire
Lease period time period hours or days
Cancellation clause Can be canceled at any It is not revocable in
point before the expiry the primary lease
 of the lease period by period
notice to the lessor
Lessor has to bear the Lessee has to bear
Risk of obsolesce
risk the risk
The lessor is
Lessor is a financial
specialized in services
investor and does not
Specialized services of handling the asset
provide any
or equip and
additional services
maintaining it

On the basis of number and nature of parties involved in a

transaction there may be the following types of lease:

(i) Sale and Lease back –

Under this type of lease the owner of the asset sells the asset to the
lessor and takes it back on lease under the lease agreement i.e. the
lessee is the owner of the asset. This type of lease helps in transfer-
ring the ownership from true owner to the lessor. This exchange of
title helps (previous owner) the lessee in liquidating the funds tied up
in a particular asset.

Hence, the seller of the asset becomes the lessee and the buyer of the
asset becomes the lessor. The seller (lessee) receives the cost of
asset and the right to use the asset, while the buyer enjoys the
ownership of asset and lease rentals for the agreed period.

It is generally used in cases where assets are not subjected to depreci-

ation and in industries where free finance is provided to the leasing
company.

E.g. Bank Lockers

(ii) Direct Lease –

In a Direct Lease, the lessee and owner of asset are different entities.
It can be of two types:

Bipartite Lease – In a Bipartite Lease, two parties are involved in a

lease transaction i.e. equipment supplier or lessor and lessee. It is
structured as an operating lease with inbuilt facilities like –

Upgrade lease – It provides an option to upgrade the equipment in

future

Swap lease – It provides an option to replace an equipment with

a similar equipment in working condition.

Tripartite Lease – In a Tripartite Lease the equipment supplier,

lessor, lessee are different entities i.e. three parties are involved in a
lease transaction.

It is a sales aid lease under which the equipment supplier arranges

for lease finance in by –

• Providing reference about the customer to the leasing

company
• Negotiating the terms with the customer
• Writing lease on his own account and discounting the lease
receivables with designated leasing company

On the basis of the domicile of the equipment manufac-

turer there are three types of lease:

(i) Domestic lease – A lease in which all the parties under the
lease contract are of the same country i.e. the equipment supplier, the
lessor and lessee are domiciled in the same country, it is a domestic
lease.

(ii) International or Cross border lease – In a cross border

lease, the lessor and lessee are domiciled in different countries
(iii) Import Lease – In an import lease, mainly the equipment sup-
plier is from a foreign country, the lessor and lessee may be in the
same country.

Other types of Lease:

Leverage lease

In such a lease agreement, the lessor buys an asset through borrowed

funds. Since huge capital is involved in purchase of heavy machiner- ies
and equipment, therefore, borrowed funds are used to finance an asset.
Generally there are three parties involved – a lessee (user), a lessor
(leasing company) and a financer (Banks and Financial institu- tions).
The lessor (leasing company) provides 20%-40% of the pur- chase
value of the asset through equity capital and the remaining amount is
borrowed from commercial bank or financial institutions (financer).
Hence it is financed partly by debt and partly by equity.
 • Owner and user or lessor and lessee – They may be
individuals, partners, joint stock companies, corporation or
financial institutions
• Joint lessor or lessee
• Lease broker – merchant banker, subsidiaries, private
merchant
• Lease financier

Parties involved in Lease Financing –

(ii) Asset – The asset, property, equipment is the subject matter of

the contract. It may be an automobile, plant and machinery, equip-
ment, land and building, factory, business, aircraft etc. Ownership of
asset is separated from use of asset during the lease period.

(iii) Term Period – The time period for which the asset is taken on
lease is called lease period. Every lease has a specified or definite
period after which it expires. On the basis on contact between the les-
sor and lessee the lease period may be of two types:

• Primary lease period – Time in which investor wants the

interest on investment
• Secondary ease period – Time for charging nominal rental
(iv) Consideration – Lease Financing involves consideration in form of
lease rentals to be paid by the lessee to the lessor for a speci- fied term period.
The amount of lease rental is decided by taking into account –

• the cost of investment

• cost of repair and maintenance
• depreciation
• taxes
• and adjusted value of cash flows (time value of money).

Modes of terminating Lease

At the end of the lease period, There can be four possible outcomes of lease
expiration:

1. The lease is renewed on a perpetual basis or extended for a definite

period
2. The asset reverts back to the lessor
3. The lessor sells the asset to a third party
4. Lessor sells asset to the lessee

Parties may mutually agree to any one of the following alternatives at the
beginning of the lease term.