Leasing and Hire Purchase

Unit II

Today
   

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

Introduction to Asset Finance

Modes of financing assets

1.

2. 3.

Purchase outright with cash, bank loan or overdraft Leasing Finance Hire/Contract purchase Finance

PURCHASE OUTRIGHT


Advantages of purchase  Can own the asset  The owner of the asset from a tax perspective can claim capital allowances  The owner is not tied into potentially inflexible medium or longlongterm agreements which may be difficult to terminate Disadvantages of purchase  The purchases hasto pay the full cost of the asset up front out of working capital, or debt finance, which adds to the cost  A small company will have limited bargaining power and knowledge with regards to the potential discounts available  The cost cannot be spread to coincide with money coming in to the business  Maintenance and servicing of the asset  Banks can withdraw overdrafts and loans at short notice and demand early repayment  Unable to take advantage of the tax benefits of deducting the cost of rental from your taxable income  The owner has to take all the risk

Leasing and hire purchase Finance



Leasing and hire purchase are financial facilities which allow a business to use an asset over a fixed period, in return for regular payments. The business customer chooses the equipment it requires and the finance company buys it on behalf of the business.

Equipments for leasing and Hire purchase

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

Leasing as Source of Finance

Leasing as Source of Finance



A financial arrangement that provides a firm with the advantage of using an asset without owning it, may be termed as Leasing Institute of Charted Accountants of India A lease is an agreement where by the lessor conveys to the lessee, in return for rent, the right to use an asset for an agreed period of time. time.  Lessor is a person who conveys to another person (lessee) the right to use an asset in consideration of a payment of periodical rental, under a lease agreement. agreement.  Lessee is a person who obtains from the lessor, the right to use the asset for a periodical rental payment for an agreed period of time  Leasing finance company is a company which buys the equipment on behalf of the lessee

 

Ownership never passes to the business customer Instead, the leasing company claims the capital allowances and passes some of the benefit on to the business customer i.e lessee, by way of reduced rental charges. The business customer can generally deduct the full cost of lease rentals from taxable income, as a trading expense. The business customer will normally be responsible for maintenance of the equipment.

 Financial


lease: also called capital lease or lease:

 

Financial lease with the purchase option, where at the end of pre-determined period, prethe lessee has the option to buy the equipment / asset at a pre-determined value. prevalue. Finance lease which is long term and where the asset is hired to only one lessee. lessee. A financial lease is non cancelable in nature. nature. The Lessee is responsible for the maintenance of the asset leased

 Full

Payout lease The Lessor recovers the full value of the leased asset with in the period of the lease by way of lease rentals and residual value. value.  True Lease The Typical tax-related taxbenefits, such as investment tax credit, depreciation tax shields etc., are offered to the lessor.

Operating Lease


Operating lease which is short-term and where the shortasset may be hired to several lessees. The lease is terminable by giving stipulated notice as per the agreement. The risk of obsolescence is enforced on the lessor who will also bear the cost of maintenance and other relevant expenses. A variant type of operating lease. Lessor is not concerned with the repairs and maintenance of the leased asset.

Net lease:
 

Financial Lease vs Operating Lease

1. 2. 3.

4.

5.

Financial lease The asset leased out is use specific for the lessee Lessee bears the ownership risk Lessee bears the risk of obsolescence Lease period coincides with the life of the asset Cost of repairs & maintenance are borne by the lessee The lease can not be cancelled by either of the parties

1.

2. 3. 4. 5.

6.

Operating lease May be used commonly by a number of users Lessor bears the ownership risk Lessor bears the risk of obsolescence Lease period is generally small Cost of repairs & maintenance are borne by the lessors Lease can be cancelled

 Leveraged

lease: part or whole of the lease: financial requirement involved in a lease are arranged with the help of a financier. financier.  Sale and Lease back: the owner of an back: asset sells it to the lessor, and gets the asset back under the lease agreement. agreement.  Consumer leasing: leasing of consumer leasing: durables such as TV, Refrigerators etc., etc.  Balloon lease : Lease rentals are low at the inception, high during the mid years and low during the end of the lease. lease.

 Close

end leasing: the asset leased out is leasing: reverted to the lessor. A rental agreement lessor. that puts no obligation on the lessee to purchase the leased asset at the end of the agreement  Open end leasing: A rental agreement that leasing: obliges the lessee to purchase the leased asset at the end of the agreement  Swap leasing: lessee is allowed to exchange leasing: the equipment leased out whenever the original asset has to be sent to the lessor for some repair or maintenance. maintenance.

leasing: lessee further subleases the leasing: asset to the end user, retaining a fee  Import leasing: leasing of imported capital leasing: goods  Cross border leasing: lessor in one country leasing: leases out assets to a lessee to another country  International leasing: leasing company leasing: operates in different countries through its branches
 Wrap

Advantages of leasing
 

Avoid having to pay the full cost of the asset up front and using up working capital or borrowed money The lessee can reduce tax bill by deducting the full cost of lease rentals from taxable income For companies that either do not pay tax or pay at the small company rate, the 100% tax allowances of lease rental are normally more beneficial than capital allowances for outright purchase options Maintenance and other asset management service items can be written into operating lease or contract hire contracts The risk is carried by the leasing company

Disadvantages of Leasing


Lease rentals are payable soon after entering into lease agreement while in new projects cash generation may start after gestation period. The cost of financing is higher than debt financing.

Accounting Treatment of Lease



The leased asset is shown on the balance sheet of the lessor. Depreciation and other tax shields associated with leased asset are claimed by the lessor. The entire lease rental is treated as an income in the books of the lessor and expense in the books of lessee.

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



Adjustment in P/L A/C Receipt of lease rentals Debit cash Credit lease rentals Recording lease rentals 1. Debit lease rental 2. Credit P/L A/c Provision for Depreciation 1. Debit statutory Depreciation 2. Credit leased asset Charging statutory depreciation 1. Debit P/L A/c 2. Credit Statutory Depreciation

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

5.Introducing Lease Equalization Account( LEA)
1. 2.

Debit LEA Credit lease Adjustment account Debit P/L A/c Credit LEA

6. Transfer of LEA to Profit & Loss A/c

1. 2.

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

Hire Purchase as a source of financing

Hire purchase - definition



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


Goods are let out on finance by a finance company to the hire purchaser customer Buyer is required to pay an equal amount of periodic installments during a given period Ownership transfers at the payment of the last installment

Features
   

Buyer takes immediate possession of the goods and agrees to pay installments Each installments is a hire charge Ownership transfers to the buyer at the last installment In case of any default the seller has the right to reposses goods and forfeit the amount already received The hirer or customer has the option of terminating the agreement anytime but will not get the amount that has been already paid.

Leasing vs Hire purchase

 

In leasing the Ownership never passes to the business customer Depreciation & investment allowance cannot be claimed by lessee Entire lease rental is tax deductible by lessee Lessee does not enjoy the salvage value of the asset No deposit is required in leasing The extent of finance is 100% as no down payment required Maintenance cost is borne by the lessor except in finance lease Leased assets are shown by way of foot note only by lessee

Ownership transfers to the buyer at the last installment Depreciation & investment allowance can be claimed by hirer Only the interest is tax component deductible for hirer Hirer enjoys the salvage value of the asset 20% deposit is required in hire purchase The extent of finance is not 100% because of down payment Hirer bears the cost of maintenance Asset is shown in b/s of the hirer

Accounting Treatment for Hire Purchase

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.

Entries in the books of Hirer



Purchase of an asset on hire purchase

 

Asset on hire purchase debit Hire purchase vendor a/c credit Hire vendor ac debit Bank A/c Credit Depreciation on asset a/c debit Asset account credit


Payment of an asset purchased on hire purchase

 

Depreciation of an asset purchased on hire purchase

 

SECOND ENTRY

 

P & L a/c debit Depreciation a/c credit

Entry in the books of vendor on hire purchase sale

HIRE PURCHASE SALE
 

Hire purchaser a/c debit Hire purchase sale a/c credit (with the cash price of goods) Bank a /c debit Hire purchaser a/c credit Hire purchaser debit Interest on hire purchase sale a/c credit

WHEN PAYMENT IS RECEIVED

 

FOR INTEREST