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By
G.Venkatachalam M.Com,MBA,M.Phil,(Ph.D)
Assistant Professor/Finance/JIT
1
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What is leasing?
Leasing is an arrangement between two parties
the leasing company( lessor ) and the
user/(lessee) , where by the lessor arranges tobuy the capital equipmentfor the use of the
lessee for an agreed period of time in return
for thepayment of rent.
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Why leasing not buying?
Buying office equipmentinvolves:
An initial outlay of cash,
or the need to get a loan.
The equipment may
become obsolete.
Some equipment has a
low resale value.
Leasing involves:
No outlay of cash initially.
minimal initial
expenditures.
Rental pays (by lessee) are
tax deductible .
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Process of leasing:Seller
Lessor
Lessee
UsesBusinessAsset
Purchase the Business Asset
Pays Rent
Agreement to give asset
After agreed period ,lessor takes the asset back
Lessor= owner of asset
Lessee= user of asset
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Types of lease :
lease
Financial
lease
Operating
lease
Leverage
lease
Cross
border
lease
Sale and
lease back
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Financial lease
Capital lease, long term lease, net lease or close lease.
The lessee enters into on irrevocable / non cancelable
contract with the lessor The lessee uses the equipment, maintains it, insures,
bears the risk of obsolescence etc.
Lease with a purchase option where lessee purchases the
equipment after the lease period is over/lease for full
economic life of the equipment
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Operating lease
Service lease, short terms lease or true lease.
Lease for a limited period
Can be terminated by notice.
Maintenance expenses borne by lessor
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DIFFERENCE BETWEEN FINANCIALLEASE AND OPERATING LEASE
Period
Settlement
Maintenance
Risk Assumption
Delivery & Disposal
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Leverage lease
Leasing of those assets which requires huge capital Three parties, lessor lessee & lender.
Lessor borrows money from the lender to purchase theasset.
Lessor provides 20% to 30% finance to own the asset.
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Sale and lease back
A firm first sells the asset to lessor & then takes it on lease.
Asset sold at market value so, the lessee gets cash & as
well as right to use the asset.
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Cross border house:
International leasing/ transnational leasing.
Lease transaction between lesser & lessee of two different
countries includes expert leasing.
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TYPES OF LEASE AGREEMENTS contd
Direct Lease - Under direct leasing, a firm acquires the rightto use an asset from the manufacturer directly. The
ownership of the asset leased out remains with the manufacturer
itself. The major types of direct lessor include manufacturers,
finance companies, independent lease companies, special purposeleasing companies etc
Dry Lease Under dry lease agreement the asset owner
(LESSOR) provides the asset without the energy required to
operate the asset.
Wet Lease - Under wet lease agreement the asset owner
(LESSOR) provides the asset with the energy required to
operate the asset. Mostly in practice in the Airline industry.
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Why has Leasing Grown so Fast?
Beneficial to both lessee and lessor:For Lessee:
Leasing may be the only source of financing
No outside security/collateral needed
Low documentation cost
Leasing can finance a higher % of equipment thanbank loans
Governments allow lessees to deduct full lease
payments from their income before tax.13G.Venkatachalam M.Com, MBA,M.Phil, Ph.D /AP/Finance/JIT
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For Lessor:
Ownership of asset
Transaction costs lower
Lighter regulations, because they are notdeposit taking institutions.
Tax incentives and depreciation shield.
Better control on utilization of funds.
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Disadvantages
Not suitable mode of project finance as
project does not generate cash immediately to
pay rent. Lease does not get the benefit of capital gain
by selling the asset.
The cost of lease finance is higher than debitfinancing ( high rentals ).
If rent is not paid regularly then lessor suffer
from loss.15G.Venkatachalam M.Com, MBA,M.Phil, Ph.D /AP/Finance/JIT
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ADVANTAGES OF LEASING
1. SAVING OF CAPITAL: Leasing covers the full cost of the equipment
used in the business by providing 100% finance. The lessee is not to
provide or pay any margin Manufacturer Lessor.
2. FLEXIBILITY AND CONVENIENCE: The lease agreement can be
tailor- made in respect of lease period and lease rentals according to the
convenience and requirements of all lessees.
3. PLANNING CASH FLOWS: Leasing enables the lessee to plan its
cash flows properly. The rentals can be paid out of the cash coming
into the business from the use of the same assets.4. IMPROVEMENT IN LIQUADITY: Leasing enables the lessee to
improve their liquidity position by adopting the sale and lease back
technique.
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ADVANTAGES OF LEASING
you don't have to pay the full cost of the asset upfront, so you don't use up your cash or have to borrowmoney
you pay for the asset over the fixed period of time thatyou use it
you can spread the cost over a longer period of time,and ease your cash flow by matching payments to yourincome
the business can usually deduct the full cost of leaserentals from taxable income
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ADVANTAGES OF LEASING
you won't have to worry about an overdraft or otherloan being withdrawn at short notice, forcing earlyrepayment
if you use an operating lease or contract hire, you maynot have to worry about maintenance
the leasing company carries the risks if the equipmentbreaks down
on long-funding leases (over seven years, andsometimes over five years) you can claim capitalallowances on the cost of the asset
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REGULATORY AUTHORITY
No specific Act or Authority regulates leasing in India. Some ofthe Acts which indirectly governs are :
Income Tax Act, 1962
Indian Contract Act, 1872
Indian Stamp Act, 1899
Motor vehicles Act, 1988
Recovery of Debts due to Bank and Financial
Institutions Act, 1993
Registration Act, 1908
Reserve Bank of India Act, 1934
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REGULATORY AUTHORITYCONTED
Sale of Goods Act, 1930
Sick Industrial Companies (Special Provisions)
Act, 1985
Transfer of Property Act, 1882Companies Act, 1956
Consumer Protection Act, 1986
Easements Act, 1882Foreign Exchange Management Act, 2000.
Hire Purchase Act, 1972
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PLAYERS IN LEASING
Financial Institutions (FIs):
Commercial Banks:
Foreign banks:Non-banking Finance Companies(NBFCs):
Foreign Institutional Investors (FIls):
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Income taxtreatment of lease:
For lessee:
Lease rentals are tax-deductible expenses.
For lessor: Lease rentals received by the lessor are taxable under the
head of 'Profits and Gains of Business or Profession'.
The lessor can claim investment allowance anddepreciation on the investment made in leased assets
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Accounting treatment of lease:
The leased asset is shown on the balance sheet of the
lessor.
Depreciation and other tax shields associated with the
leased asset are claimed by the lessor.
The entire lease rental is treated as income in the
books of the lessor and as expense in the books of the
lessee.
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Leasing industry in India:
In the year 1973 Leasing finance started in India.
First company was set up by the Chidambaram Groups
in 1973 at Madras.
Governed in India as per Indian contract Act (Sec.148-
Bailment)
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PUBLIC SECTOR LEASING:
Financial institutions
Financial institutions like ICICI, IFCI, has set up leasing
divisions.
Subsidiaries of bank
bank establishes subsidiaries for leasing such SBI started
in 1986.
Other public sector organization Public sector manufacturing companies like Bharat
Electronic ltd. (BHEL), ECIL have started leasing
equipment.
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PRIVATE SECTOR LEASING
Pure leasing Companies
Independent company without link with any other
organization.
The twentieth century finance corporation ltd. & Grover
leasing ltd.
Hire purchase & finance Companies
Companies prior to 1980 do hire purchase & financing of
vehicles, but after 1980 it was extended to leasing.
Sundaram finance ltd. & General Finance ltd.
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What is Hire purchase?
Hire purchase is a method of selling goods where by the
goods are let out on hire by a creditor (hiree) to the hire
purchase customer (hirer).
The buyer is required to pay an agreed amount in periodical
installments during a given period.
The ownership of property remains with the creditor (hiree)
and passes on to hirer only after the payment of last
installment.
Hire purchase is regulated under the Hire Purchase Act 1972
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Features
Under hire purchase system, the buyer takes
possession of goods immediately & agrees to paythe total hire purchase price in instalments
Each instalments is treated as hire charges The ownership of goods passes from buyer to seller
on the payments of the last instalments
In case the buyer makes any default in payments of
any instalments the seller has right to repossess thegoods
Normally a deposit is requested i.e. 10%
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Difference between leasing and hirepurchase:
BASIS LEASE FINANCING HIRE-PURCHASE
ownership The ownership sets with thelessor throughout theagreement.
ownership lies with thehiree till the lastinstalment is paid
by the hirer.Method of financing Its a method of financing
business assets.Its a method of financingboth business assets andconsumer
articles
Option to user No option is given to lesseeto buy the leasedassets.(except in financiallease)
Purchase option is therewith hirer.
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Contd
BASIS LEASE FINANCING HIRE-PURCHASE
Maintenance It is borne by lessee infinancial lease and lessorin operating lease.
It is borne by hirer.
Nature of expenditure Rentals are revenueexpenditure and entirerental is tax deductible.
Only interest oninstallment is revenuein nature and taxdeductible not the entireinstallments.
Salvage value Lessee not being theowner of the asset,doesnt enjoy thesalvage value of theasset.
Hirer, after being theowner of the asset enjoysthe salvage value of theassets .
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Standard provisions according to HP ACT 1959
To be valid, hire purchase agreements must be in writing andsigned by both parties. They must clearly set out the followinginformation in a print that all can read without effort:
a clear description of the goods
the cash price for the goods
the HP price, i.e., the total sum that must be paid to hire and
then purchase the goods
the deposit
the monthly instalments and
a reasonably comprehensive statement of the parties' rights
(sometimes including the right to cancel the agreement during a
"cooling-off" period).
The right of the hirer to terminate the contract when he feels like
doing so with a valid reason
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The owner's rights
The owner usually has the right to terminate theagreement where the hirer defaults in paying theinstalments or breaches any of the other terms in theagreement. This entitles the owner
to forfeit the deposit
to retain the instalments already paid and recover thebalance due
to repossess the goods (which may have to be byapplication to a Court depending on the nature of thegoods and the percentage of the total price paid)
to claim damages for any loss suffered.
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The hirer's obligations
The hirer usually has the following obligations: to pay the hire instalments
to take reasonable care of the goods (if the
hirer damages the goods by using them in anon-standard way, he or she must continue to
pay the instalments and, if appropriate,
compensate the owner for any loss in assetvalue)
to inform the owner where the goods will be
kept.
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Advantages of HirePurchasing Cash flow: payment by
instalments.
Writing down
allowances apply. Hire purchase is an
alternative funding lineto bank overdrafts
Attracts fixed rateinterest.
Others same as OutrightPurchase.
Disadvantage of hirepurchasing
Inflexible: difficult to
escape the outstandingsettlement if say, avehicle is no longerrequired.
High deposit compared
to contract hire. Business hire purchase
appears as a debt onthe balance sheetwhich could inhibit
future borrowing. More expensive than
contract hire
Burden of controllingand running fleet
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ANY QUESTION
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