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Leasing and Hire Leasing and Hire Purchase Purchase Unit II Unit II
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Page 1: Unit II Leasing and Hire Purchase

Leasing and Hire Leasing and Hire PurchasePurchase

Unit IIUnit II

Page 2: Unit II Leasing and Hire Purchase

Today Today

Introduction to Asset FinanceIntroduction to Asset Finance Modes of financing assetsModes of financing assets Leasing as a source of financing Leasing as a source of financing Accounting Treatment for LeasingAccounting Treatment for Leasing

Page 3: Unit II Leasing and Hire Purchase

Introduction to Asset FinanceIntroduction to Asset Finance

Page 4: Unit II Leasing and Hire Purchase

Modes of financing assetsModes of financing assets

1.1. Purchase outright with cash, bank Purchase outright with cash, bank loan or overdraftloan or overdraft

2.2. Leasing Finance Leasing Finance

3.3. Hire/Contract purchase FinanceHire/Contract purchase Finance

Page 5: Unit II Leasing and Hire Purchase

PURCHASE OUTRIGHTPURCHASE OUTRIGHT Advantages of purchaseAdvantages of purchase

Can own the asset Can own the asset The owner of the asset from a tax perspective can claim capital The owner of the asset from a tax perspective can claim capital

allowances allowances The owner is not tied into potentially inflexible medium or long-term The owner is not tied into potentially inflexible medium or long-term

agreements which may be difficult to terminateagreements which may be difficult to terminate

Disadvantages of purchaseDisadvantages of purchase The purchases hasto pay the full cost of the asset up front out of The purchases hasto pay the full cost of the asset up front out of

working capital, or debt finance, which adds to the cost working capital, or debt finance, which adds to the cost A small company will have limited bargaining power and knowledge A small company will have limited bargaining power and knowledge

with regards to the potential discounts available with regards to the potential discounts available The cost cannot be spread to coincide with money coming in to the The cost cannot be spread to coincide with money coming in to the

business business Maintenance and servicing of the asset Maintenance and servicing of the asset Banks can withdraw overdrafts and loans at short notice and demand Banks can withdraw overdrafts and loans at short notice and demand

early repayment early repayment Unable to take advantage of the tax benefits of deducting the cost of Unable to take advantage of the tax benefits of deducting the cost of

rental from your taxable income rental from your taxable income The owner has to take all the riskThe owner has to take all the risk

Page 6: Unit II Leasing and Hire Purchase

Leasing and hire purchase FinanceLeasing and hire purchase Finance

Leasing and hire purchase are Leasing and hire purchase are financial facilities which allow a financial facilities which allow a business to use an asset over a fixed business to use an asset over a fixed period, in return for regular period, in return for regular payments. payments.

The business customer chooses the The business customer chooses the equipment it requires and the equipment it requires and the finance company buys it on behalf of finance company buys it on behalf of the business. the business.

Page 7: Unit II Leasing and Hire Purchase

Equipments for leasing and Hire Equipments for leasing and Hire purchasepurchase

- Modernization of Business- Modernization of Business- Plant and machinery- Plant and machinery- Business cars- Business cars- Commercial vehicles- Commercial vehicles- Agricultural equipment- Agricultural equipment- Hotel equipment- Hotel equipment- Medical and dental equipment- Medical and dental equipment- Computers, including software - Computers, including software packages packages - Office equipment - Office equipment

Page 8: Unit II Leasing and Hire Purchase

Leasing as Source of FinanceLeasing as Source of Finance

Page 9: Unit II Leasing and Hire Purchase

Leasing as Source of FinanceLeasing as Source of Finance A financial arrangement that provides a firm with A financial arrangement that provides a firm with

the advantage of using an asset without owning it, the advantage of using an asset without owning it, may be termed as may be termed as LeasingLeasing

Institute of Charted Accountants of IndiaInstitute of Charted Accountants of India “ “ A lease is an agreement where by A lease is an agreement where by

the lessor conveys to the lessee, in return for rent, the lessor conveys to the lessee, in return for rent, the right to use an asset for an agreed period of the right to use an asset for an agreed period of time. time. Lessor is a person who conveys to another Lessor is a person who conveys to another

person (lessee) the right to use an asset in person (lessee) the right to use an asset in consideration of a payment of periodical rental, consideration of a payment of periodical rental, under a lease agreement.under a lease agreement.

Lessee is a person who obtains from the lessor, Lessee is a person who obtains from the lessor, the right to use the asset for a periodical rental the right to use the asset for a periodical rental payment for an agreed period of timepayment for an agreed period of time

Leasing finance company is a company which Leasing finance company is a company which buys the equipment on behalf of the lessee buys the equipment on behalf of the lessee

Page 10: Unit II Leasing and Hire Purchase

Ownership never passes to the business Ownership never passes to the business customercustomer

Instead, the leasing company claims the Instead, the leasing company claims the capital allowances and passes some of the capital allowances and passes some of the benefit on to the business customer i.e benefit on to the business customer i.e lessee, by way of reduced rental charges.lessee, by way of reduced rental charges.

The business customer can generally The business customer can generally deduct the full cost of lease rentals from deduct the full cost of lease rentals from taxable income, as a trading expense.taxable income, as a trading expense.

The business customer will normally be The business customer will normally be responsible for maintenance of the responsible for maintenance of the equipment.equipment.

Page 11: Unit II Leasing and Hire Purchase

Financial leaseFinancial lease: also called capital lease : also called capital lease or or Financial lease with the purchase option, Financial lease with the purchase option,

where at the end of pre-determined period, where at the end of pre-determined period, the lessee has the option to buy the the lessee has the option to buy the equipment / asset at a pre-determined value.equipment / asset at a pre-determined value.

Finance lease which is long term and where Finance lease which is long term and where the asset is hired to only one lessee.the asset is hired to only one lessee.

A financial lease is non cancelable in nature.A financial lease is non cancelable in nature. The Lessee is responsible for the The Lessee is responsible for the

maintenance of the asset leasedmaintenance of the asset leased

Page 12: Unit II Leasing and Hire Purchase

Full Payout lease Full Payout lease – The Lessor – The Lessor recovers the full value of the recovers the full value of the leased asset with in the period of leased asset with in the period of the lease by way of lease rentals the lease by way of lease rentals and residual value.and residual value.

True Lease True Lease – The Typical tax-– The Typical tax-related benefits, such as related benefits, such as investment tax credit, investment tax credit, depreciation tax shields etc., are depreciation tax shields etc., are offered to the lessor.offered to the lessor.

Page 13: Unit II Leasing and Hire Purchase

Operating LeaseOperating Lease Operating lease which is short-term and where Operating lease which is short-term and where

the asset may be hired to several lessees.the asset may be hired to several lessees. The lease is terminable by giving stipulated The lease is terminable by giving stipulated

notice as per the agreement.notice as per the agreement. The risk of obsolescence is enforced on the The risk of obsolescence is enforced on the

lessor who will also bear the cost of lessor who will also bear the cost of maintenance and other relevant expenses. maintenance and other relevant expenses.

Net lease:Net lease: A variant type of operating lease.A variant type of operating lease. Lessor is not concerned with the repairs and Lessor is not concerned with the repairs and

maintenance of the leased asset.maintenance of the leased asset.

Page 14: Unit II Leasing and Hire Purchase

Financial Lease vs Operating LeaseFinancial Lease vs Operating Lease

• Financial leaseFinancial lease• The asset leased out The asset leased out

is use – specific for is use – specific for the lesseethe lessee

1.1. Lessee bears the Lessee bears the ownership riskownership risk

2.2. Lessee bears the risk Lessee bears the risk of obsolescenceof obsolescence

3.3. Lease period Lease period coincides with the coincides with the life of the assetlife of the asset

4.4. Cost of repairs & Cost of repairs & maintenance are maintenance are borne by the lesseeborne by the lessee

5.5. The lease can not be The lease can not be cancelled by either cancelled by either of the partiesof the parties

• Operating leaseOperating lease1.1. May be used May be used

commonly by a commonly by a number of users number of users

2.2. Lessor bears the Lessor bears the ownership riskownership risk

3.3. Lessor bears the risk Lessor bears the risk of obsolescenceof obsolescence

4.4. Lease period is Lease period is generally smallgenerally small

5.5. Cost of repairs & Cost of repairs & maintenance are maintenance are borne by the lessorsborne by the lessors

6.6. Lease can be Lease can be cancelledcancelled

Page 15: Unit II Leasing and Hire Purchase

Leveraged leaseLeveraged lease: : part or whole of the part or whole of the financial requirement involved in a lease financial requirement involved in a lease are arranged with the help of a financier.are arranged with the help of a financier.

Sale and Lease backSale and Lease back: : the owner of an the owner of an asset sells it to the lessor, and gets the asset sells it to the lessor, and gets the asset back under the lease agreement.asset back under the lease agreement.

Consumer leasingConsumer leasing: : leasing of consumer leasing of consumer durables such as TV, Refrigerators etc.,durables such as TV, Refrigerators etc.,

Balloon lease Balloon lease :: Lease rentals are low at Lease rentals are low at the inception, high during the mid years the inception, high during the mid years and low during the end of the lease.and low during the end of the lease.

Page 16: Unit II Leasing and Hire Purchase

Close–end leasingClose–end leasing: the asset leased out is : the asset leased out is reverted to the lessor. A rental agreement reverted to the lessor. A rental agreement that puts no obligation on the lessee to that puts no obligation on the lessee to purchase the leased asset at the end of purchase the leased asset at the end of the agreementthe agreement

Open–end leasingOpen–end leasing: : A rental agreement that A rental agreement that obliges the lessee to purchase the leased obliges the lessee to purchase the leased asset at the end of the agreementasset at the end of the agreement

Swap leasingSwap leasing: : lessee is allowed to lessee is allowed to exchange the equipment leased out exchange the equipment leased out whenever the original asset has to be sent whenever the original asset has to be sent to the lessor for some repair or to the lessor for some repair or maintenancemaintenance..

Page 17: Unit II Leasing and Hire Purchase

Wrap leasingWrap leasing: : lessee further subleases lessee further subleases the asset to the end user, retaining a the asset to the end user, retaining a feefee

Import leasingImport leasing: : leasing of imported leasing of imported capital goodscapital goods

Cross border leasingCross border leasing: lessor in one : lessor in one country leases out assets to a lessee country leases out assets to a lessee to another countryto another country

International leasingInternational leasing: : leasing company leasing company operates in different countries operates in different countries through its branches through its branches

Page 18: Unit II Leasing and Hire Purchase

Advantages of leasingAdvantages of leasing Avoid having to pay the full cost of the asset up Avoid having to pay the full cost of the asset up

front and using up working capital or borrowed front and using up working capital or borrowed money money

The lessee can reduce tax bill by deducting the The lessee can reduce tax bill by deducting the full cost of lease rentals from taxable income full cost of lease rentals from taxable income

For companies that either do not pay tax or pay For companies that either do not pay tax or pay at the small company rate, the 100% tax at the small company rate, the 100% tax allowances of lease rental are normally more allowances of lease rental are normally more beneficial than capital allowances for outright beneficial than capital allowances for outright purchase options purchase options

Maintenance and other asset management Maintenance and other asset management service items can be written into operating lease service items can be written into operating lease or contract hire contracts or contract hire contracts

The risk is carried by the leasing companyThe risk is carried by the leasing company

Page 19: Unit II Leasing and Hire Purchase

Disadvantages of Leasing Disadvantages of Leasing

Lease rentals are payable soon after Lease rentals are payable soon after entering into lease agreement while in entering into lease agreement while in new projectsnew projectscash generation may start after cash generation may start after gestationgestationperiod.period.

The cost of financing is higher than debt The cost of financing is higher than debt financing. financing.

Page 20: Unit II Leasing and Hire Purchase

Accounting Treatment of LeaseAccounting Treatment of Lease

The leased asset is shown on the The leased asset is shown on the balance sheet of the lessor. balance sheet of the lessor.

Depreciation and other tax shields Depreciation and other tax shields associated with leased asset are associated with leased asset are claimed by the lessor. claimed by the lessor.

The entire lease rental is treated as The entire lease rental is treated as an income in the books of the lessor an income in the books of the lessor and expense in the books of lessee. and expense in the books of lessee.

Page 21: Unit II Leasing and Hire Purchase

Adjustment in P/L A/CAdjustment in P/L A/C

Receipt of lease rentalsReceipt of lease rentals• Debit cashDebit cash• Credit lease rentalsCredit lease rentals

Recording lease rentalsRecording lease rentals

1.1. Debit lease rentalDebit lease rental

2.2. Credit P/L A/cCredit P/L A/c

Provision for DepreciationProvision for Depreciation

1.1. Debit statutory DepreciationDebit statutory Depreciation

2.2. Credit leased assetCredit leased asset

Charging statutory depreciationCharging statutory depreciation

1.1. Debit P/L A/cDebit P/L A/c

2.2. Credit Statutory DepreciationCredit Statutory Depreciation

Accounting and reporting for financial leaseAccounting and reporting for financial lease- in the books of lessor- in the books of lessor

Page 22: Unit II Leasing and Hire Purchase

5.Introducing Lease Equalization Account( LEA)5.Introducing Lease Equalization Account( LEA)1.1. Debit LEADebit LEA

2.2. Credit lease Adjustment account Credit lease Adjustment account

6. Transfer of LEA to Profit & Loss A/c6. Transfer of LEA to Profit & Loss A/c1.1. Debit P/L A/cDebit P/L A/c

2.2. Credit LEACredit LEA

Lease Equalization Account: Lease Equalization Account: Temporary account Temporary account introduced to provide a cushion to offset the introduced to provide a cushion to offset the differences between annual lease charge and differences between annual lease charge and statutory depreciation.statutory depreciation.

Accounting and reporting for financial leaseAccounting and reporting for financial lease- in the books of lessor- in the books of lessor

Page 23: Unit II Leasing and Hire Purchase

Hire Purchase as a source of Hire Purchase as a source of financingfinancing

Page 24: Unit II Leasing and Hire Purchase

Hire purchase - definition Hire purchase - definition

An agreement under which goods are let An agreement under which goods are let on hire and under which the hirer has an on hire and under which the hirer has an option to purchase them in accordance option to purchase them in accordance with the terms of the agreement.with the terms of the agreement. Goods are let out on finance by a finance Goods are let out on finance by a finance

company to the hire purchaser customercompany to the hire purchaser customer Buyer is required to pay an equal amount of Buyer is required to pay an equal amount of

periodic installments during a given periodperiodic installments during a given period Ownership transfers at the payment of the Ownership transfers at the payment of the

last installment last installment

Page 25: Unit II Leasing and Hire Purchase

Features Features Buyer takes immediate possession of the Buyer takes immediate possession of the

goods and agrees to pay installmentsgoods and agrees to pay installments Each installments is a hire chargeEach installments is a hire charge Ownership transfers to the buyer at the lastOwnership transfers to the buyer at the last

installment installment In case of any default the seller has the In case of any default the seller has the

rightrightto reposses goods and forfeit the amountto reposses goods and forfeit the amountalready receivedalready received

The hirer or customer has the option of The hirer or customer has the option of terminating the agreement anytime but will terminating the agreement anytime but will not get the amount that has been already not get the amount that has been already paid.paid.

Page 26: Unit II Leasing and Hire Purchase

Leasing vs Hire purchaseLeasing vs Hire purchase

Ownership transfers to the buyer at Ownership transfers to the buyer at the last installment the last installment

Depreciation & investment allowance Depreciation & investment allowance can be claimed by hirercan be claimed by hirer

Only the interest is tax component Only the interest is tax component deductible for hirerdeductible for hirer

Hirer enjoys the salvage value of the Hirer enjoys the salvage value of the asset asset

20% deposit is required in hire 20% deposit is required in hire purchase purchase

The extent of finance isThe extent of finance isnot 100% because ofnot 100% because ofdown paymentdown payment

Hirer bears the cost of maintenance Hirer bears the cost of maintenance Asset is shown in b/s of the hirer Asset is shown in b/s of the hirer

In leasing the Ownership never passes to In leasing the Ownership never passes to the business customerthe business customer

Depreciation & investment allowance Depreciation & investment allowance cannot be claimed by lesseecannot be claimed by lessee

Entire lease rental is tax deductible by Entire lease rental is tax deductible by lesseelessee

Lessee does not enjoy the salvage value of Lessee does not enjoy the salvage value of the asset the asset

No deposit is required in leasing No deposit is required in leasing

The extent of finance is 100% as no down The extent of finance is 100% as no down payment requiredpayment required

Maintenance cost is borne by the lessor Maintenance cost is borne by the lessor except in finance leaseexcept in finance lease

Leased assets are shown by way of foot Leased assets are shown by way of foot note only by lesseenote only by lessee

Page 27: Unit II Leasing and Hire Purchase

Accounting Treatment for Hire Accounting Treatment for Hire PurchasePurchase

The cost of the fixed asset is shown on the balance sheet of Hirer. 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.

Page 28: Unit II Leasing and Hire Purchase

Entries in the books of HirerEntries in the books of Hirer Purchase of an asset on hire purchase Purchase of an asset on hire purchase

Asset on hire purchase debitAsset on hire purchase debit Hire purchase vendor a/c creditHire purchase vendor a/c credit

Payment of an asset purchased on hire purchase Payment of an asset purchased on hire purchase Hire vendor ac debitHire vendor ac debit Bank A/c CreditBank A/c Credit

Depreciation of an asset purchased on hire Depreciation of an asset purchased on hire purchasepurchase Depreciation on asset a/c debitDepreciation on asset a/c debit Asset account creditAsset account credit

SECOND ENTRYSECOND ENTRY P & L a/c debitP & L a/c debit Depreciation a/c credit Depreciation a/c credit

Page 29: Unit II Leasing and Hire Purchase

Entry in the books Entry in the books of vendor on hire purchase saleof vendor on hire purchase sale

HIRE PURCHASE SALEHIRE PURCHASE SALE Hire purchaser a/c debitHire purchaser a/c debit Hire purchase sale a/c credit (with the cash Hire purchase sale a/c credit (with the cash

price of goods)price of goods)

WHEN PAYMENT IS RECEIVEDWHEN PAYMENT IS RECEIVED Bank a /c debitBank a /c debit Hire purchaser a/c creditHire purchaser a/c credit

FOR INTERESTFOR INTEREST Hire purchaser debitHire purchaser debit Interest on hire purchase sale a/c credit Interest on hire purchase sale a/c credit