LEASING

Learning Outcomes
• To provide an understanding about the
concept and to make them understand the
importance of leasing in business.
 MEANING

A lease may be defined as :

• a contractual arrangement / transaction in which a party
• owning an asset / equipment (lessor)
• provides the asset for use to another / transfer the right to use
the equipment to the user (lessee)
• over a certain / for an agreed period of time
• for consideration in form of / in return for periodic payment
(rental)
• at the end of the period of contract (lease period) ,the asset
/equipment reverts back to the lessor
• unless there is a provision for the renewal of the contract.
 ESSENTIAL ELEMENTS
1.Parties to the contract
– Essentially there are two parties to the contract , namely ,
the owner (lessor) and the user (lessee) .
– Lessor as well as lessee may be individuals ,partnership ,
joint stock companies, financial institutions.
– There may be joint lessors
– There may be lease broker ,who acts as an intermediary in
arranging the lease deal.
– Private merchant bankers are also acting as lease brokers.
– They charge fee ranging from 0.5% to 1% for their services.
– A lease contract may involve a lease financier, who
refinances the lessor, either by providing term loans or by
subscribing to equity .
2. Assets

The asset under a lease contract includes :

– Automobile
– Plant and Machinery
– Equipment
– Land and Building
– Factory
– A Running Business
– Aircraft , Ship
etc
3. 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.
4. Term of lease

It is the period for which the agreement of lease financing

remains in operation.

• Every lease should have a definite period otherwise it will be

legally inoperative.
• The lease period may sometimes spread stretch over the entire
economic life of the asset or a period shorter than the useful
life of the asset.
• The lease may be perpetual, that is, with an option at the end
of lease period to renew the lease for the further specific period
5. Lease rental

The consideration which the lessee pays to the lessor for

the lease transaction is the lease rental.

It is so structured as to compensate the lessor for the :

• investment made in the asset , the interest on
• investment , repairs borne by the lessor ,and
• servicing charges over the lease period.
•
6. Mode of terminating lease

The lease is terminated at the end of the lease period and

various courses are possible , namely :

• lease is renewed on perpetual basis or for a definite period

• the asset reverts to the lessor
• the asset reverts to the lessor and the lessor sells it to the
other party
• the lessor sells the asset to the lessee

The parties may mutually agree to , and choose , any of the

aforesaid alternatives at the beginning of the lease term.
 CLASSIFICATION

An equipment lease transaction can differ on the basis of :

• The extent to which the risks and rewards of ownership are

transferred.

• Number of parties to the transaction.

• Domiciles of the equipment manufacturer , the lessor and

the lessee .
1. Finance Lease

According to the International Accounting Standard (IAS-17)

in a finance lease the lessor transfers to the lessee,
substantially all the risks and rewards incidental to the
ownership of the asset whether or not the title is
eventually transferred .
It involves payment of rental over an obligatory non –
cancelable lease period , sufficient in total to amortize the
capital outlay of the lessor and leave some profit.
In such leases , the lessor is only a financier and is usually
not interested in the assets.
Such leases are also called as Full Payout Leases as they enable a
lessor
to recover his investment in the lease and derive a profit.
 Types of assets included under such lease are :

• Ships Aircrafts
• Railway Wagons Land
• Building
• Heavy Machinery
• Diesel Generating Sets
• etc
•
 The IAS-17 stipulates that a substantial part of the
ownership related risks and rewards in leasing are
transferred when :

• The ownership of the equipment is transferred to the

lessee by the end of the lease term , or

• The lessee has the option to purchase the asset at a price

which is expected to be sufficiently lower than the fair market
value at the date option becomes exercisable and at the
inception of the lease it is reasonably certain that the
option will be exercised , or

• The lease term is for a major part of the useful life of the
asset.
 Features of Finance Lease

• The lessee selects the equipment according to his

requirements , from its manufacturers or distributors
• The lessee negotiates and settles with the manufacturer or
distributor , the price , the delivery schedule , installation ,
terms of warranties , maintenance and payment and so on.
• The lessor purchases the equipment either directly from the
manufacturer or distributor (under straight forward leasing) or
from the lessee after the equipment is delivered (under sale
and lease back).
• The lessor then leases out the equipment to the lessee.
• A finance lease may provide a right or option , to the lessee ,
to purchase the equipment at a future date.
• The lease period spreads over the expected economic life of
the asset.
• The lessee is entitled to exclusive and peaceful use of the
equipment during the entire lease period provided he pays the
rental and complies with the terms and conditions.
• As the equipment is chosen by the lessee ,
* the responsibility of its suitability ,
*the risk of obsolescence and
*the liability for repairs ,
*maintenance and
*insurance of the equipment rests with the lessee.
2. Operating Lease

According to the IAS-17 in operating lease also known as

Service Lease ,
the lessor does not transfer all the risks and rewards
incidental to the ownership of the asset and the cost of
the asset is not fully amortized during the primary lease
period.
the lessor provides services ( other than the financing
of the purchase price ) attached to the leased asset ,
such as maintenance , repairs and technical advice.
The lease rental in an operating lease includes :
• a cost for the services provided and
• the lessor does not depend on a single lessee for
recovery of his cost.
 Operating lease is generally given for :

• Computers
• Office equip
• Automobiles
• Trucks Other
• equip
• Telephones etc
 Features of Operating Lease

• An operating lease is generally for a period significantly

shorter than the economic life of the leased asset.
• In some cases it may be even on hourly , daily ,weekly or
monthly basis .
• The lease is cancelable by either party during the lease
period .
• Since the lease periods are shorter than the expected life of the
asset , the lease rentals are not sufficient to totally amortize
the cost of the assets.
• The lessor does not rely on the single lessee for recovery
of his investment.
• He has the ultimate interest in the residual value of the asset
• The lessor bears the risk of obsolescence , since the lessee
is free to cancel the lease at any time .
• Operating leases normally include maintenance clause:
*requiring the lessor to maintain the leased asset and
*provide services such as
*insurance ,
*support staff ,
*fuel and so on .
 Examples :

• Providing mobile cranes with operators

• Chartering of aircrafts and ships , including the provision
of crew , fuel and support services
• Hiring of computers with operators
• Hiring a taxi for a particular travel , which includes service
of driver , provision for maintenance , fuel , immediate
repairs , and so on.
3. Sales and Lease Back

• It is an indirect form of leasing .

• The owner of an equipment / asset sells it to a
leasing company (lessor) which leases it back to the
owner (lessee) .
 Example:

• The sale and lease back of safe deposits vaults by banks under
which banks sell them in their custody to a leasing company at
a market price substantially higher than the book value .
• The leasing company in turn offer these lockers on a long –
term basis to the bank .
• The bank sub- leases the lockers to its customer .
• The lease back arrangement in sale and lease back type of
leasing can be in the form of finance lease or operating
 ADVANTAGES to the lessor

• Full security
• Tax benefit
• High profitability
• Trading on equity
• High growth potential
 LIMITATIONS

• Restriction on the use of equipment

• Limitations of financial lease
• Loss of residual value
• Consequences of default
 LIABILITIES OF LESSEE

• Reasonable care
• Not to make unauthorized use
• To return the goods
• Not to set up an adverse title
• To pay the lease rental
• To insure and repair the goods
 LIABILITIES OF LESSOR

• Delivery of the goods

• Peaceful possession
• Fitness of goods
• To disclose all defects