A lease is usually a Contractual agreement in which the lessor conveys the right to use property, plant, or equipment, usually

for a stated period of time, to the lessee.

Lessor = OWNER of property

Lessee = USER of property

Largest group of leased equipment involves: Information technology, Transportation (trucks, aircraft, rail), Construction and Agriculture.

Essential elements of Lease Agreement

1. Parties to the contract: Lessor and Lessee 2. Assets: which is the subject matter of lease financing< may be an automobile, plant and machinery, equipment, land and building, factory, a running business, an aircraft and so on. 3. Ownership separated from user: The essence of leasing

 4. Term of Lease: Every lease should have definite period, otherwise it will be legally inoperative. < The asset period may sometimes strecth over the entire economic life of the asset. < or it might be with an option to renew it.

5.Lease Rentals: It is structured so as to compensate ( in the form of Depreciation) the lessor for the investment made in asset, and for expenses like interest on the investment, repairs and servicing charges borne by the lessor over the lease period.

6. Modes of Terminating the Lease: < possible courses are: a. The lease is renewed on a perpetual basis or for a definite period, or b. The asset reverts to the lessor, or c. The asset reverts to the lessor and lessor sells it to a third party, or d. The lessor sells the asset to the lessee.

Types of Leasing
1. Financial Lease 2. Operating Lease 3. Leverage Lease 4. Sale and Lease back 5.Domestic lease and International lease 6. Cross Border Lease

Financial Lease
Financial Lease:- A financial lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred.

And are also called as Capital lease/ Close lease /Long term lease.
In other words Finance lease can be a lease under which the present value of the minimum lease payments at the inception of the lease exceeds or is equal to substantially the whole of the fair value of the leased asset.

 Example: Suppose the Hrithik Roshan company takes a new automobile on lease for three year. Also assume that at the end of three years the Hrithik company will be called to take the ownership of vehicle at no extra cost. Here not only the vehicle is taken on lease but also the AB company is using the lease agreement as a means of financing the automobile. This type is called capital lease or finance lease. < The high cost of equipments such as Air craft, land and building and heavy machinery are leased under financial lease.

Finance lease
Examples of situations which would normally lead to a lease being classified as a finance lease:
The lessor transfers ownership of the asset to the lessee at the end of the lease term The lease term is for the major part of the economic life of the asset even if title is not transferred The leased assets are of a specialised nature such that only the lessee can use them without major modifications being made

Contd..
The leased assets cannot be easily replaced At the inception of the lease, the present value of the minimum lease payments (MLP) amounts to at least substantially all of the fair value of the leased asset

Operating Lease
Also known as short term lease/ True lease/ Service lease. The operating lease is one which is not a finance lease. Under operating lease, the lessor gives the right to lessee to use the asset or property for a specified period of time may be a month, six month a yea or few years. The lease is terminable by giving stipulated notice as the agreement.

 Normally Lease rentals will be higher as compared to other leases. The risk of obsolescence is enforced on the lessor who will also bear the cost of maintenance and other relevant expenditure. Where lessee is interested in tiding over temporary problem.

 Example: Let up suppose that MY enterprises owns a complete 6th floor in Eden Tower, a multi story building. Further assume that MY enterprises gives some rooms of this floor on lease to XY corporation. Now if the value of this building increase due to good business activity then the lessor i.e., MY enterprises can take the benefit of this increase by either selling out the rooms or by increasing the rental amount. On the other hand if the building decreases in value than also the MY enterprises will be the sufferer of loss. This type of leasing is called operating lease.

Difference between Financial lease and Operating Lease:

1. Is like an installment loan. Its a legal commitment to pay for the entire cost of asst plus interest over a period of time. Where lease rental my exceed cost of equipment. Its rental agreement where lessee do not pay more than the cost of asset over the contractual period.

2. lessee makes provision for maintenance or taxes which are paid separately by him. lessor provides for maintenance expenses and taxes. 3. The risk of obsolescence is assumed by the lessee. Lessor or leasing company assuems risk of obsolescence.

4. contract period ranges from medium to long-term ranges from intermediate to short term. 5. Contracts are usually non-cancellable they are usually cancellable either by lessor or lessee. 6. Air craft, land and building and heavy machinery are leased. Computers, office equipment, automobiles and truck etc. are leased. 7. Benefits claimed as deduction in income tax Depreciation and other finance charges. Only lease rentals 8. Accounted in profit and loss account and balance sheet in lessees book payment accounted only in profit and loss account.

Sale and lease back

An indirect form of leasing. The owner of an equipment/ asset sells it to a leasing compnay (lessor) that leases it back to the owner (lessee). Example: sale and lease back of safe deposit vaults by banks. Banks sell the vaults in their custody to a leasing company at a market price substantially higher than thebook value and leasing company in turn offers these lockers on a long term basis to the bank. The bank sub leases to its customers.

What is safe deposit vaults

safe deposit boxes are used to store valuable possessions, such as jewelleries, gemstones, precious metals, marketable securities, important documents such as wills, property deeds, passports or computer data storage that need protection from theft, fire, flood, tampering or other reasons. In the typical arrangement, a customer pays the bank a fee for the rent and use of the safe deposit box, which can be opened only with production of an assigned key plus the banks own guard key after the proper identification and signature of the person authorized to have access to the box.

Direct lease
The lessee and the owner of the equipment are two different parties. a. equipment supplier-cum lessor B. lessee

Single investor lease & Leveraged lease

Single investor lease: There are only two parties to the lease transaction: the lessor and lessee. The leasing company (lessor) funds the entire investment by an appropriate mix of equity and debt funds.

Leveraged lease: There are 3 parties to the transaction A. the lessor ( the equity investor) B. the lender C. the lessee Here the leasing company( equity investor) buys the asset through substantial borrowing with full recourse to lessee.

Domestic lease
If all the parties to the agreement namely equipment supplier, lessor and lessee are domiciled in the same country.

International or cross border lease When lessor and lessee are domiciled in different countries then it is classified as cross border lease.

1. Financing of capital goods 2. additional sources of finance 3. Less costly 4. Ownership preserved: do not dilutes equity stake of promoters 5. Simplicity: no interest calcn. involved 6. Tax benefits: lease rentals 7. Obsolescence risk is averted

1. Full security: since he is always owner of the asset 2. Tax benefits: Depreciation 3. High profitability: since rate of return to lessor is more than his pays on borrowings 4. Trading on equity: use of low equity and more of borrowed funds 5. High growth potential: scope in recession and depression also

Limitations of Leasing
1. Restrictions to use of asset: as lessee cant make any alterations or additions to the leased asset 2. Loss of residual value: to the lessee 3. understatement of lessees asset: As the asset does not form the lessees asset 4. If lessee does not pay rentals regularly lessor suffers 5. If a manfr. wants to discontinue the business he has to terminate the contract by paying heavy penalties

1. Description of lessor, lessee, and the equipment. 2. Amount, time, and place of lease rental payments 3. Time and place of equipment delivery 4. Lessee's responsibility with regard to leased equipment (maintenance, repairs, registration) 5. Insurance to be taken by the lessee on behalf of lessor 6. Variations if any in lease rentals due to external factors ( interest rate, fiscal policy ) 7. Option of lease renewal 8. Return of equipment on expiry of the lease period 9. Arbitration procedure in the event of dispute

Hire-Purchase

Hire

agreement

Hire purchase is a mode of financing the price of the goods to be sold on a future date. In a hire purchase transaction, the goods are let on hire, the purchase price is to be paid in installments and hirer is allowed an option to purchase the goods by paying all the installments

Salient features of Hire-Purchase System,

1. 2. 3. 4. Hire-Purchase System is governed by Hire-Purchase Act 1972 It is an agreement of hiring It is an agreement between Hirer and Hire Vendor Terms and conditions between the parties are entered and recorded in a document called Hire-Purchase Agreement. 5. Cash price of goods is paid in installment on agreed terms. 6. The title to goods passes on last payment 7. The Hire Vendor (Seller) can take possession of goods if Hirer fails to pay installment 8. The Hirer is not responsible for risk of loss of goods, till the ownership is transferred. 9. The Hirer cannot mortgage, hire or sell or pledge the goods 10. The Hirer has got a right to terminate the agreement at any time before the property so passes.

Difference between Leasing and Hire purchase

1.Ownership: Lies with leasing company or lessor and never transferred to lessee. It is transferred to hirer on payment of last installment. 2. Depreciation: Only Lessor is entitled to claim tax benefit on it Hirer (owner) is entitled to claim depreciation tax shield 3.Capitalization: Is done in the books of Lessor Is done in the books of Hirer 4. Tax benefit on payments: Entire Lease payments are eligible in the books of lessee Only the hire interest is eligible in the book

5. Benefit of Salvage value: lessor has the right to claim The hirer claims as he is prospective owner 6. Magnitude: leasing used for acquiring high cost assets such as airplane, ships, machinery. usually used for acquiring relatively low cost assets such as automobiles, office equipments 7. Down payments: No down paymen is required here It is required and to made to the extent of 20-25% 8. Maintenance of asset: In fin lease- lessee In operating Lease- lessor It is hirers responsibility 9. suitability: Not suitable for low capital enterprises which desires to show strong asset position Highly suitable for low capital enterprises.