WHAT IS LEASE

Lease arrangement is a contractual

agreements between lessor and lessee,
giving a legal right to lessee for the use of
leased asset for a specific period and in
return, the lessor as legal owner of the asset,
receives a predetermined rate of return in the
shape of periodic lease rentals.
Every lease involves two parties.
The user of the assets is called the Lessee.
The Lessee (user) promises to make a series
of payments to the Lessor (Owner).

The lease contract specifies the monthly or

semi-annually payments with the first
payment (Beginning Mode).

The payments are usually level, but their

time pattern can be tailored to the lessees
need. When a lease is terminated, the lease
equipment (Asset) reverts to the Lessor.
However, the lease agreement provides the
user the option to buy the asset.

The Two Basic Types of Leases available to

the business firm are operating and financial
leases.
OPERATING LEASE
Short-term Lease
Cancelable prior to the expiry date at little
or no cost.
Lessor is responsible for maintenance
and upkeep.
The sum of the lease payments does not
provide for full recovery of the assets cost.

Includes TVs, Computers, Photocopiers,

Cars.
FINANCE LEASE
Long term lease.
Non-cancelable prior to expiry.
Lessee is responsible for maintenance
and upkeep of the asset.
Lease period approximates assets
economic life.
The sum of the lease payments exceeds
the assets purchase price.
Includes specialist equipment, heavy
industrial equipment.

Virtually all-financial lease arrangements fall

into one of three main types of lease
financing, these are;
Sale and leaseback
Direct Lease
Leveraged Lease
Sale Type Lease
Sale and Leaseback
oA transaction that involves the sale of asset
to a leasing company and a subsequent lease
of the same asset back to the original owner,
who continues to use the asset.

Direct Lease
oUnder Direct lease, a company acquires the
use of an asset it did not own previously.
oFor leasing arrangements involving all but
manufactures, the vendors sells the assets to
the lessor who, in turn, leases it to the lessee.
oA direct lease is a lease that does not give
rise to manufacturer/ dealer profit (or loss) to
the lessor.

Leveraged Lease
oA lease involving three parties: a lessor,
lessee and funding source.
oThe lessor borrows from the funding source
by assigning future rentals on a non-recourse
basis.
oThe lessor puts up a minimal amount of its
own funds and is entitled to the full tax
benefits of asset ownership.

Hire Purchase Agreement

An agreement between Hiree and Hirer.
Hiree and manufacturer can be same.
Hirer is entitled to claim depreciation.
Hirer can charge only interest portion of HP
payments as expenses for tax computation.
Once the hirer has paid all installments, he
becomes the owner of the asset and can
claim its salvage value.

Sales Type Lease

oA finance lease from the lessors perspective
that gives rise to manufacturers or dealers
profit to the lessor.
Accounting Treatment
Finance Lease

Lessor

Lesee

Operative Lease

Balance
Sheet

Income
Stat.

Balance
Sheet

Income Stat.

Receivable

Interest
Income

Lease Asset

Rental Income+ Dep

Loan Payable

Interest
Expense

Loan
Payable

Interest Expense

Asset

Depreciation

Footnote
Disclosure

Rent Expense

Lease
Obligation
Payable

Interest
Expense

Tax and Accounting Books

For tax purpose, all leases are treated as
operating lease.
The difference in treatment is in accounting
books only.

ADVANTAGES OF LEASING
A lessee avoids many of restrictive
covenants that are normally included in as
a part of long term loans like minimum
liquidity etc.
Leasing may provide 100% financing
which is not there in other long term loans
which need equity contribution also.

ADVANTAGES
Leasing allows the lessor to depreciate
assets as a tax benefit or expanse which
is not otherwise possible.
Sale lease back allows to increase the
liquidity by way of converting existing
asset into cash which can be used as
working capital.

DISADVANTAGES OF LEASING
At the end of the lease period the lessor
realizes the salvage value which could
have been available to lessee if he
purchases it.
Lessee cannot make improvements in the
leased asset with lessors permission.
As per agreement. The lessee has to pay
rentals even if the asset becomes
obsolete.