Chapter 22- Leasing & Hire Purchase Financing

Excel BooksExcel BooksFINANCIAL MANAGEMENT, Dr. Sudhindra Bhat

Copyright © 2008, Dr Sudhindra Bhat

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LEASING & HIRE PURCHASE FINANCING


22

Chapter



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CHAPTER OUTLINE• Meaning and concept of leasing• Leasing – Definition, Features & Modus

Operandi• Hire Purchase – Definition, Features &

Modus Operandi• Types• Types of Lease• types of lease, documentation and legal

aspects• operating lease • services lease• financial lease• Other types:

– Leveraged leases– Full payout and non payment lease– Sale and leaseback– cross border leases

• Types of Hire Purchase • Consumer Installment Credit • Industrial and Commercial Credit

• Leasing Vs Hire Purchase• Distinction • Advantages & Disadvantages • Lease Evaluation • Lessees’ View • Lessor’s Perspective • Techniques of Financing and

Appraisal • Appraisal of Limit for Bank Lending • Computation of lending / Drawing

Limit• Supervision and Follow -up• Accounting Aspects• Accounting for Leasing • Accounting for Hire Purchase • Legal Aspects• Income Tax • Sales Tax Aspects • Motor Vehicles Act



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Dr. Bhatt

MEANING AND CONCEPT OF LEASING Lease is defined by the international accounting standard as an agreement

whereby the lessor conveys to the lessee in return for rent the right to use an agreed period of time.

According to jack broyles, lease is the method of acquiring the right to use equipment of real property for consideration.



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Dr. Bhatt

“A lease is classified as a financial lease if it secures for the lessor the recovery of his capital outlay plus a return on the funds invested during the lease term’.

‘A lease is an operating lease’, according to the said guidance note of ICAI, ‘if it does not secure for the lessor the recovery of his capital outlay plus a return on the funds invested during the lease term’.



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WHY LEASING?

Acquisition of new plants and equipments are often required by business organizations. While it is necessary to see the profitability in investing on new equipment, one must equally be aware of the necessary to conserve cash resources to maintain liquidity, under such circumstance leasing arrangements may come in handy for various reasons.



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TYPES OF LEASE, DOCUMENTATION AND LEGAL ASPECTS

OPERATING LEASE: In operating lease, the lease is usually for a shorter term and is generally

cancelable. As the asset is leasable repeatedly to several person, the operating lease is usually said to be a nonpayout lease.

SERVICE LEASE : It is an equipment leasing under which the lessor provides financing as well

as servicing of the assets during the lease period. The lessor will covenant with the lessee to provide maintenance and servicing of the leased asset during the existence of the lease.

FINANCIAL LEASE: Financial lease is a long term lease usually coinciding with the economic life

of the asset and is noncancellable. It operates as a long term debt financing and is usually full-payout as, in contrast to operating lease, it is usually a single lease repaying the cost of the asset. They play a major role in financing of building of buildings and equipments to industries.



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FINANCIAL LEASE OPERATING LEASE

The leased asset is use-specific. Usually the lessor buys the asset identified by the lessee and leases out to him.

The leased asset is of common-use activity. The lessor already owns the asset and leases it out to several users successively.

The risks and rewards incidental to ownership are passed on to the lessee. The lessor only remains the legal owner of the asset.

The lessee is given the use of the asset for certain period. Ownership and benefits and risks associated with it remain with the lessor.

Therefore, the lessee bears the risk of obsolescence. He is responsible for maintenance, insurance, taxes, etc.

Therefore, the lessor bears the risk of obsolescence. He is responsible for maintenance, insurance, tax, etc.

It is an intermediate to long term lease essentially covering the expected useful life of the asset.

It is a short term lease the lease period being significantly less than the useful life of the asset.

During the primary lease period, usually the initial 3 or 5 or 8 years, the lease cannot be cancelled.

The lease is usually cancelable at short notice.

The lessors' capital outlay is fully amortized during the primary lease period. During a single lease, the lessor recovers through the lease rentals his investment on the leased asset along with interest and profit. Hence, it is called full-pay-out lease.

The lessors' capital outlay is not fully amortized during the period of a single lease. The lease rentals recovered during a lease-period are not sufficient to cover fully the cost of leased asset along with an accept able return thereon. Hence, it is called a non-payout lease.

A financial lease is basically a debt equivalent i.e.. it is a form of borrowing in disguise. Since, it is a financing decision, the lessee has to decide whether to lease or borrow and buy the asset.

An operating lease is basically a rental agreement. Since it is an investment decision, the lessee has to decide whether to lease or buy the asset.

The lessor takes the role of a financier. Usually, the lessor is a financial institution and cannot render specialized service connection with the asset.

The lessor is specialized in handling and operating the particular asset and usually provides in specialized services.

This type of lease is generally suitable for equipment which is tailor made and does not have ready resale or release market eg. heavy machines, etc

This type of lease is suitable for equipment which has longer economic life and ready resale or re-lease market i.e., automobiles, computers, office equipments.

COMPARE FINANCIAL AND OPERATING LEASE



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OTHER TYPES1. LEVERAGED LEASES

2. FULL PAYOUT AND NON PAYMENT LEASE

3. SALE AND LEASEBACK

4. CROSS BORDER LEASE



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HIRE PURCHASE

Definition: As per Sec 2(c) of The Hire Purchase Act, 1972, a hire purchase is

an agreement under which goods are let on hire and under which the hirer has

an option to purchase them.



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Hire Purchase Features Cancellability Termination of Hire Purchase Agreement Ownership Period Installments Parties Add-on-Rate



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TYPES OF HIRE PURCHASEBased on whether the underlying assets are consumer goods or producer

goods, hire purchase, as a type of installment credit, are of two varieties:

Consumer installment credit and

Industrial and Commercial credit.



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DIFFERENCE BETWEEN LEASE & HIRE PURCHASE

LEASE HIRE PURCHASE

1. Financing company is called the lessor and the user of the leased asset is called the lessee.

1. Financing company is called the hiree (hire vendor) or owner and the user of the asset is called hirer.

2. During the entire period of operation of the contract, the ownership of the asset remains with the lessor. The lessee has only the right to the exclusive use of the asset. After completion of the contract the possession of the asset is passed to the lessor and the same can be leased out to some other lessee at the option of the lessor.

2. During the period of opera tion of the contract, the ownership of the asset, for all practical purposes vests with the hirer. After completion of the contract period and subject to payment of total amount of installments, the ownership legally passes on to the hirer.

3. Since the ownership of the asset is legally vested with the lessor, the same appears as fixed asset in his balance sheet.

3. As the hiree transfers all the risks and rewards of ownership the asset appears either as stock in trade or as receivables in the balance sheet of the hirer (user). The amount shown in the balance sheet is the total of installments paid by him less the interest component.

4. Depreciation can also be claimed by the lessor for computation of his taxable income.

4. Depreciation can also be claimed by the hirer for computation of his taxable income.

Lease rentals are 100% tax deductible. 5. Hire purchase instalments are partly treated as capital repayment and the balance as interest expenses - the latter amount is only tax deductible.



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ADVANTAGES & DISADVANTAGES

Convenience Flexibility Faster and Cheaper Non-restrictive Better use of Funds 'Off Balance Sheet' finance increases borrowing capacity Protects lessee against Obsolescence Specialised Services & Maintenance Tax Benefits



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DISADVANTAGES OF LEASING:

Disguised Debt-financing

Sale Tax Burden

Psychological Dissatisfaction

Higher Cost

Loss of Subsidy/Attraction



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Advantage of Hire Purchase

Chapter 22- Leasing & Hire Purchase Financing

Documents

operating lease

lease term

single lease

lease services

lease rentals

service lease

nonpayout lease

long term lease