Leasing and hire purchase

LEASINGDEFINITION

A written agreement under which a property owner

allows a tenant to use the property for a specified

period of time and rent.

The lessee (person taking out a lease) agrees to pay a number of fixed or flexible installments over an agreed period to the lessor, who remains the owner

of the asset (item) throughout the period of the lease.

STEPS IN LEASING

FEATURES

Leasing a product is similar to renting it

A contract lasts over a number of years,

usually between 2 and 10, depending on the cost and usable life of the product.

Have the full use of a piece of equipment without having to pay the full cost of the item in one go.

TYPES OF LEASING
Lease

Finance lease

Operating lease

Sale and Lease Back

Leveraged leasing

Direct leasing

a)FINANCIAL LEASE (CAPITAL

LEASE)

Long-term, non-cancellable lease contracts are known as financial leases. The essential point - it contains a condition whereby the lessor agrees to transfer the title for the asset at the end of the lease period at a nominal cost. At least it must give an option to the lessee to purchase the asset he has used at the expiry of the lease.

The lease agreement is irrevocable. All the risks incidental to the asset ownership are transferred to the lessee who bears the cost of maintenance, insurance and repairs. Only title deeds remain with the lessor.

b) OPERATING LEASE

Contrast to the financial lease

A lease agreement gives to the lessee only a limited

right to use the asset.

The lessor is responsible for the upkeep and

maintenance of the asset.

The lessee is not given any uplift to purchase the

asset at the end of the lease period.

c) SALE AND LEASE BACK

Sub-part of finance lease

The owner of an asset sells the asset to a party

(the buyer), who in turn leases back the same

asset to the owner in consideration of lease

rentals.

Under this arrangement, the assets are not physically exchanged but it all happens in records only.

Sale and lease back transaction is suitable for

those assets, which are not subjected

depreciation but appreciation, like land.

The seller assumes the role of a lessee and the buyer assumes the role of a lessor. The seller gets the agreed selling price and the buyer gets the lease rentals.

d) LEVERAGED LEASING

A third party is involved beside lessor and lessee.

The lessor borrows a part of the purchase cost (say 8

0 %) of the asset from the third party i.e., lender

The asset so purchased is held as security against the loan.

The lender is paid off from the lease rentals directly by the lessee and the surplus after meeting the claims of the lender goes to the lessor.

e) DIRECT LEASING

Under direct leasing, a firm acquires the right to use an asset from the manufacturer directly. The ownership of the asset leased out remains with the manufacturer itself.

ADVANTAGES of LEASING

No large outlay:

The cost is spread over a number of

years; there is no need to pay the

entire amount upfront.

Security:

The product is still owned by the

leasing company, meaning that they

have better security on finance.

Flexibility and convenience The lease agreement can be tailormade in respect of lease period

and lease rentals according to the

convenience and requirements of all

lessees

DISADVANTAGES
1.

No Ownership

2.

Costly option - high interest rates, costlier

than straight buying

3.
4.

Long Term Expense

Maintenance No working capital

5.

LEASE AGREEMENT

A document under which a landlord and tenant set forth the

rights and obligations of each party with respect to an

apartment, rental unit, or other real property owned by the landlord and used by the tenant.

An instrument conveying the possession of real property for a fixed period in consideration of the payment of rent.

Clauses in lease agreement

Nature of the lease Description Delivery and redelivery Period

Lease rentals
Use Title

Repairs and maintenance

Alteration

Accounting aspect of Leasing

Operating lease :
Is capitalized in the book of lesser
Lease payments are treated as income of the lessor and expense of the lessee Depreciation of the assets should on the basis of normal depreciation policy of the lessor for similar assets

Financial lease Must be capitalized in the books of lessee

a)

At the time of inception leased asset is shown as an asset of B/S of the lessee Its VALUE = PV of the committed lease rentals

b)Payments are financial charges (expense in P/L) and principal amount (deducted from lease payable in B/S)

C)Leased asset is depreciated in the books of lessee

HIRE PURCHASE

Hire purchase is used to buy expensive items which a person cannot afford to pay outright: e.g. a car A down payment is usually paid and the balance is paid over several months (monthly instalments).

Definition
According to hire purchase act of 1972.An agreement
under which goods are let on hire under which the hirer has an option to purchase them in accordance with the terms of agreement and include an agreement under which Possession of goods is delivered by the owner thereof to a person on the condition that such person pays the amount in periodic payments The property of the goods is to pass to such a person on the payment of the last installment. Such a person has a right to terminate the agreement any time before the property so passes.

Operation of HP transaction

The finance company purchases the equipment from the supplier and gives it on hire. The hirer is required to make a down payment of 20-25% of the cost and pay the balance amount along with interest in advance or arrears over a time period of 36-48months Alternatively, instead of the down payment, the hirer as to deposit an equal amount as a fixed deposit with the finance co which provides entire finance on hire purchase terms, repayable with interest in emi over 36-48 months.

Continued..

Deposits and the accumulated interest is returned to the hirer upon the payment of last installment. The interest on each hire purchase installment is computed on the basis of flat rate of interest is applied to the declining balance of original loan amount to determine the interest component of installment for a given flat rate of interest, the equivalent effective rate of interest is higher.

Present industry order

SREI International Finance Sundaram Finance Cholamandalam Finance Mahindra & Mahindra GE Capital Shriram Finance Tata Finance Countrywide Finance Citicorp

Advantages

Allows you to buy more expensive items on credit. It may be easier to get a hire purchase agreement than a loan or credit card.

Disadvantages

You do not own the goods until you have paid off the full amount. The hire purchase company can take back goods if you do not keep up with the payments. If goods are taken back you may still owe money on them. Hire purchase agreement can be more expensive than a bank loan or credit card.

Accounting Treatment for Hire Purchase

The cost of the fixed asset is shown on the balance sheet. The cost shown excludes any interest paid. The net book value is the cost less any provision for depreciation.

In the profit and loss account the interest paid during the year is shown, together with any depreciation. In the balance sheet the liability for future payments is shown. The liability does not include interest. The short term and long term liabilities are shown separately.

Process of Hire Purchase

The Dealer, contracts with finance co. for financing his hire purchase deals. The customer selects the goods for HP, and dealer arranges for the complete set of documents. Down payment by customer on completion of proposal form.

Dealer sends documents to finance co. with request to purchase the goods, and accept the HP transaction. The finance co. signs the agreement and sends copy along with EMI details to dealer. Dealer delivers the goods to the customer, property passes on to the finance co.. Hirer pays EMIs, and on last payment , the ownership passes on to him, with loan completion certificate by the finance co.

Eligibility to enter into HP transactions

People with a regular and stable income, and capacity to pay installments from the current income The person must be competent to enter into a contract . Minor is not eligible Foreigners and people not having permanent residence in the country are disqualified for availing such forms of credit sales.

GUIDELINES FOR BANKS AS FAR AS HIRE PURCHASE BUSINESS IS CONCERNED

I. For the present, banks shall not themselves undertake directly (i.e, departmentally) the business of hire purchase II. Banks which have set up subsidiaries (i.e, a company in which it holds not less than 51% of the shares ) for the business of equipment , leasing ,merchant banking etc, may undertake the hire purchase business either through such a subsidiary or through a separate subsidiary.

Leasing

v/s

hire purchase
Ownership of the property is transferred to the hirer on the payment of the last payment. The hirer is entitled to claim depreciation tax shield. Capitalization of asset is done in the books of hirer. Only the hire interest is eligible for tax computation in the books of the hirer. Finance charges are allocated to HP period equally

Ownership of the property lies with lessor, not transferred to lessee. Lessor, is entitled to claim depreciation tax shield. Capitalization of the asset is done in the books of lessor The entire lease payments are eligible for tax computation in the books of lessee Lessor income declines as the investment o/s in lease declines

Leasing

v/s hire purchase

The lessor has the right to claim the benefit of salvage value Leasing is used as a source of finance, usually for acquiring high cost assets i.e., machinary, ships, airplanes,etc No down payment is required for acquiring the use of leased assets. Leased assets are disclosed by way of a note only in the books of lessee

The hirer can claim benefit of salvage value as the owner of the asset. H.P is used as a source of finance usually for acquiring relatively low cost assets i.e., automobiles, office equip Down payment is required to be made for acquiring the assets and a margin maintained to the extent of 20-25% Asset bought on hire purchase will be shown as asset

Leasing

v/s hire purchase

The lessee has to maintain the leased asset in case of financial lease, up keep is the responsible of lessor in case of operating lease. Not suitable for low capital enterprises An asset given by a leasing company is treated as fixed asset of lessor All receipts from lessee is taken into lessor p&l a/c

The hirer is responsible to ensure the maintenance of asset bought. It is highly suitable for low capital enterprises which need to show a strong asset position in their balancesheet The hire vendor normally shows the asset let under HP either as stock in trade or receivables Only interest portion is taken into vendor p&l a/c