LEASING

By Deepti
Grover
 Lease
  Leases are contractual arrangements


by which the owner of property (the

"lessor") allows another person (the
"lessee") to use the property for a
stated period of time in exchange for
cash payments or other compensation.
• Lessee
A person who is granted a lease; tenant.

• Lessor
A person granting a lease; landlord


 LEASING
 For example: Hiring equipment, such
as a car or a piece of machinery, to
avoid the capital cost involved in
owning it. In some companies it is
advantageous to use capital for other
purposes and to lease some equipment,
paying for the hire out of income. The
equipment is then an asset of the
leasing company rather than the lessor.
Sometimes a case can be made for
leasing rather than purchasing, on the
grounds that some equipment quickly
becomes obsolete.
 Types of Lease
• Financial Lease : A lease where
essentially all the benefits of
ownership transfer to the lessee; also
known as a capital or full payout
lease.


• Operating Lease : 
 Essentially long term rent, not a
capital expense transaction. A lease
where some of the benefits of
ownership do not transfer to the lessee
and remain with the lessor.
 FINANCIAL LEASE

• A finance lease or capital lease is a type of lease. It is a
commercial arrangement where:
• the lessee (customer or borrower) will select an asset
(equipment, vehicle, software);
• the lessor (finance company) will purchase that asset;
• the lessee will have use of that asset during the lease;
• the lessee will pay a series of rentals or installments for
the use of that asset;
• the lessor will recover a large part or all of the cost of the
asset plus earn interest from the rentals paid by the
 Characteristics of Financial
Leases:
(1) the duration of the lease generally coincides with the


functional or economic life of the property,



(2) the lease may not be canceled, and



(3) the lessee is often responsible for maintaining the



property. Some refer to these types of leases as

“capital” leases.

 Comparison of Financial Lease
with Operating Lease

• A finance lease differs from an operating lease in that:
• in a finance lease the lessee has use of the asset over
most of its economic life and beyond (generally by
making small 'peppercorn' payments at the end of the
lease term).
• In an operating lease the lessee only uses the asset for
some of the asset's life.
• in a finance lease the lessor will recover all or most of
the cost of the equipment from the rentals paid by the
lessee.
 Accounting of Leases:
• Financial leases are included on the balance sheet of the
lessee


• Operating leases are off-balance-sheet financing for the

lessee (included only in the notes to the financial
statements)
 Impact on Accounting
• Since a finance lease is capitalized, both assets and
liabilities (current and long-term ones) in the balance
sheet increase. As a consequence, working capital
decreases, but the debt/equity ratio increases,
creating additional leverage.
• Finance lease expenses are allocated between interest
expense and principal value much like a bond or loan;
therefore, in a statement of cash flows, part of the
lease payments are reported under operating cash
flow but part under financing cash flow. Therefore,
operating cash flow increases.
• Under operating lease conditions, lease obligations are
not recognized; therefore, leverage ratios are
understated and ratios of return (ROE and ROA) are
overstated.

 Advantages of Leasing :
 1. Leasing is less capital-intensive than purchasing, so if
a business has constraints on its capital, it can grow
more rapidly by leasing property than it could by
purchasing the property outright.


2. Capital assets may fluctuate in value. Leasing shifts

risks to the lessor, but if the property market has shown
steady growth over time.


3. Leasing may provide more flexibility to a business

which expects to grow or move in the relatively short
term, because a lessee is not usually obliged to renew a
lease at the end of its term.

 Advantages Continues:
 4. When controlling cash flow is critical and you don't
have time to worry about your equipment, leasing can be
a great option.


 5. If the obsolescence risk is high then lease will be

preferable.


6. Requires no restriction on a company's financial

operations, while loans often do;

7. Spreads payments over a longer period (which means

they'll be lower) than loans permit;
•
 Implications of Leasing :
The implications to be on off balance sheets financing with


respect to tax and accounting issues:



1) It hides the true leverage of the firm.

2)
4) There may be increase in liability of the firm, which is not
disclosed currently.
5)
3) It may lead to artificial increase in profits, which in turn
means high taxes.



 Disadvantages of Leasing :
1)It can lead to increase in liability, which
may lead to losses in future.
2)
4)It has serious ethical implications with
regard to the disclosure.
5)
3) It may involve artificial increase in current

profits .



Thank you