LEASING

A contractual arrangement under which the owner of an asset (lessor) agrees to allow the use of his asset by another party (lessee) in exchange of periodic payment (lease-rents) for a specified period.

ESSENTIAL ELEMENTS OF LEASING

1. Number of parties to the contract a) The Owner Lessor b) The User Lessee 2. Assets Any property or Equipment. 3. Consideration Lease Rents. 4. Lease Period entire life of asset or less. 5. Use v/s Ownership ownership remains with lessor. 6. Termination of Contract After expiry of the Lease Period a) Renewal for another period. b) Lessee may buy the asset. c) The lessor can give the asset to third party.

TYPES OF LEASING
1. 2. 3. 4. 5. 6.

OPERATING LEASE FINANCIAL LEASE SALE AND LEASE BACK DIRECT LEASE LEVERAGED LEASE PRIMARY AND SECONDARY LEASE

1. OPERATING LEASE Salient Features

(Also known as Service Lease) Short term lease. Lease period less than useful life of asset. Option of renewal. Lessor is generally responsible for maintenance, insurance and taxation. More expensive than Financial Lease. Equipments having technology risk are leased this way.

2. FINANCIAL LEASE Salient Features

Long term lease. Total lease rentals exceeds or is equal to fair value of asset. Usually non cancelable by the lessee before its expiry. Hence less risky for lessor. Lessee is responsible for maintenance, insurance and service of the assets. Commonly used for leasing Land, Building and Large Fixed Equipments. Option with the lessee to renew the lease on expiry.

3. SALE AND LEASE BACK Salient Features

The firm sells its already owned assets to another firm and hires it back. The lessor is normally a financial institution. Preferred by a firm suffering the shortage of funds. Lease provisions are generally similar to those of Financial Lease.

4. DIRECT LEASE Salient Features

Lessor is not already the owner of assets. The lessor acquires the assets from the manufacturer or the leasing company.

5. LEVERAGED LEASE Salient Features

It involves a third party who is a Lender. For expensive assets such as planes or ships. Lessor borrows funds from lender (like banks etc) and himself acts as equity participant.

6. PRIMARY AND SECONDARY LEASE Salient Features

Divided into two parts Primary Lease and Secondary Lease. Primary Lease provides for recovery of the cost of the asset. Secondary Lease provides for the profit from the rentals.

ADVANTAGES OF LEASING TO LESSEE

1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Avoidance of Cash Outlay. Minimum Delay. Easy Source of Finance. Shifting Of Risk of Obsolescence. Liquidity Position of Firm Increases. Tax Advantage. Convenience and Flexibility. No Floatation Cost. Less Maintenance. No Disposable Problem.

LIMITATIONS OF LEASING TO LESSEE

1. 2. 3. 4. 5. 6.

Higher Cost. Risk of Being Deprived Of Use of Assets. No Alteration or Change In Asset. Loss of Ownership Incentives. Penalties on Early Termination of Lease. No Right on Salvage Value of Asset.

ADVANTAGES OF LEASING TO LESSOR

1. 2. 3. 4.

Higher Profit Tax Benefit Quick Return Increased Sales

LIMITATIONS OF LEASING TO LESSOR

1. 2. 3. 4. 5.

High risk of obsolescence. Competitive Market. Price Level Changes. Long Term Investment. Management of Cash Flow.

Lease Financing V/s Debt Financing

Initial Investment can be avoided by lessor Less time consuming

Initial Investment to be done in form of margin money

More time consuming High effect on Debt/Equity ratio Reflects on liability side of B/s Initial Costs of raising the funds are higher

No effect on the Debt/equity ratio

Does not reflect on liability side of B/s

Initial Costs of raising the funds are low

Lease Financing V/s Hire Purchase

Ownership lies with the lessor Depreciation claimed by lessor Funds involved are high No margin money required Maintenance is responsibility of lessor Salvage value goes to the lessor

Ownership passes on to the use Depreciation claimed by hirer Comparatively low funds involved Margin money required Maintenance is responsibility of hirer Salvage value goes to the hirer

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