SlideShare a Scribd company logo
1 of 49
Download to read offline
LEASIN
G
MohammadMaksudulHuqChowdhury
LEASING
Leasing is a typical financing arrangement. It is an
agreement which allows one party to use the asset
without having the title of it. From an economic
perspective, leasing can be defined as “a contract
between two parties where one party (the lessor)
provides an asset for usage to another party (the
lessee) for a specified period of time, in return for
specified payments” (Fletcher et. al., 2005). This is
also reflected in accounting-related definitions:
According to the Accounting Standard IAS 17 “a
lease is an agreement whereby the lessor conveys
to the lessee in return for a payment or series of
payments the right to use an asset for an agreed
period of time”.
LEASING
Leasing is referred to as asset based financing. As
lessors retain ownership of the assets they lease
throughout the life of the contract, these leased
assets are therefore an inherent form of collateral in
such contracts.
Conventional bank lending focuses on the loan
repayment by the borrower from two sources: a
primary source, the cash flow generation, and a
secondary source, credit enhancements and
collateral. Leasing is focused on the lessee’s ability
to generate cash flows from the business operations
to service the lease payments, as the lessor retains
legal ownership of the asset.
LEASING
Hence, leasing separates the legal ownership of an
asset from its economic use. Ownership of the asset
may or may not pass to the customer at the end of
the lease contract. Contracts, where legal ownership
of the asset passes directly to the customer at the
start of the agreement, are not considered to be
leases.
Parties of Leasing
There are two parties:
Lessor : Owner of the asset at the
beginning of the contract
Lessee : User of the asset.
Why Do We Go for Leasing
1. Facilitates the acquisition of needed equipment.
2. Makes available funds that would otherwise be
tied up in the ownership of fixed assets.
3. Possible tax advantages.
4. Possible improvement of the statement of
financial position (B/S).
Types of Leasing
Four most important types:
1. Operating/Service lease,
2. Financial/Net lease,
3. Sale and lease back and
4. Combination lease.
Operating/Service Lease
1. Provides for both financing and maintenance
2. Not fully amortized. Lessor expects to recover all
costs from subsequent renewal payments or
residual values on disposal.
3. Often gives the lessee the right to cancel the
lease before term.
4. Lessor bears the risk of obsolescence.
5. Used for both customized equipment/asset and
standard equipment/asset.
Financial/Net Lease
1. Does not provide for maintenance service.
2. Not cancelable.
3. Generally fully amortized. Added rent to the
lessor.
4. Lessee bears the risk of obsolescence.
5. The lease happens through a leasing company
buying a new equipment chosen by the lessee.
6. Used for Standard type of equipment/asset.
Sale and Leaseback
1. Under a sale and leaseback, a firm that owns a
property sells it to another firm and
simultaneously executes an agreement to lease
the property back for a stated period.
2. An alternative to a mortgage.
3. Considered as a special type of financial lease.
Combination Lease
It combines some features of different types of lease.
Leasing Credit Criteria, Terms & Rates
Lease financing techniques and terms differ
depending on:
• the lessor,
• the length of lease,
• the equipment or assets leased and
• the prevailing interest rate.
Leasing Credit Requirement
The standards of granting lease are similar to
lending
• But less stringent than borrowing.
• Lessor is interested in:
a. Financial condition of lessee and
b. Other pertinent business information.
• Generally leasing companies are less restrictive
than bank with respect to documentation and
financial strength of lessee.
• Primary considerations of a leasing company
a. Intrinsic value of the equipment
b. Marketability of equipment
c. Cash flow of lessee
Length of Lease Period
• Length of lease period is between 2 years and 10
years in majority cases.
• Leases for less than 3 years are usually for rolling
stock (trucks, forklifts etc.) and office equipments
(computers, photocopiers etc.).
What can be done after the expiry of
lease terms?
Three alternatives for the lessee:
• New lease with a new asset.
• Purchase the property from lessor for residual value.
• Renew the lease for residual rent.
Alternatives after Lease Period
• New Lease with New Asset is the right choice when
the asset is rapidly changing in cost and efficiency
(e.g. computers get obsolete).
• Purchase the Property at a Residual Value
(Original Cost + Interest) – (Rents Paid)
- FASB defines residual value as the fair
market value at the end of lease term.
- No set practices determining the residual
purchase prices, but typically 10% of
original cost is charged.
Alternatives after Lease Period
• Purchase the Property at a Residual Value
(Continued)
- The use of fixed purchase price option may
prevent classification of lease agreement a true
lease for tax purpose. Thus it may remove some
of the depreciation and investment credit options
available to lessor.
• Renew the lease at reduced rent: This option would
be exercised if doubt remained about whether to
purchase the asset.
- Generally, renewed leases require reduced
rent (2-5% of original list price)
- Sometimes renewed leases incorporate
declining rent.
Lease Rates
• Lease rates vary widely depending on the risks
involved.
• More specialized the equipment, higher the risk.
• Longer lease term, higher the risk to the lessor.
• Often Add-on-Interest method is applied in
determining lease rates.
 Add-on-percentage is multiplied by the contract
term (in years) to get the total charge.
For example, 5% add-on interest for Tk.200,000 in 6
year lease.
Add-on-amount = (6 x 5% of 200,000)
= Tk.60,000
Total Charge = 200,000 + 60,000 = 260,000
The add-on is often quoted as a separate increment
to the contract.
Lease Rates
 Sometimes, lease rate is quoted as a certain
percentage of original cost per month.
For example, 2% of the cost of equipment per month
is approximately equal to 5% add-on).
For an asset of Taka 200,000, monthly rent = Taka
4,000
When the lessee has high credit rating, lease
agreement may be written on a simple interest basis.
 Companies with substantial taxable income
sometimes enter into leasing business to get
depreciation and investment tax credit.
Lease Rates
 As a result, interest rate charged in leasing may
be below the rates for long-term loans.
- However, the lessee is giving up the tax benefits
arising from depreciation.
 So, leasing is primarily advantageous for a
lessee who is unable to use depreciation deductions
and investment tax credits.
Reserve and Setup Charge
Lessee required to put up a lease deposit equal to
first and last month’s rent (lease payment) for each
year of the contract life.
If lenient, lessor might charge 2 months’ rent + setup
charge or security deposit.
TAX ASPECT OF LEASING
To determine the type and character of tax
deductions, a lessee must determine whether the
lease agreement is a true lease or a conditional
sales contract.
- If the agreement is a true lease, the lessee may
deduct rental payments for tax purpose.
If the agreement is a conditional sales contract the
payments will be considered payments for the
purpose of acquiring the property and deductions will
be allowed for depreciation and possibly interest
expense.
Conditional Sales Contract
A lease agreement is called conditional sales
contract if it meets any of the following conditions.
1. Portions of the periodic payments are
specifically applicable to an equity to be
acquired by the lessee.
2. Title will be acquired upon payment of a stated
amount of rentals.
3. The total payments required for a relatively short
period of use constitute an excessively large
fraction of the total amount required for having
the title of the asset.
Conditional Sales Contract
4. The agreed rental payments materially exceed
the current fair market rental value for the same
asset.
5. The property may be acquired under a purchase
option
or the price is relatively small when compared to the
total payments the lessee is required to make.





















termlease
theofendat the
propertyofValue
option
purchase
underPrice
Conditional Sales Contract
6. Some portion of the periodic payment is
specifically designated as interest or is
otherwise readily recognizable as the equivalent
of interest.
7. Title will be acquired on payment of aggregate
amount that approximates the initial sales price,
plus interest and carrying charges at which the
lessee could have purchased the equipment
when entered into the agreement.














chargescarryinginterest
priceSalesInitial
Amount
Aggregate
Leveraged Leases
Leveraged leases involve three parties – lessor, lessee
and a lender to the lessor. Usually these leases are
financial leases (Lessee covering maintenance,
insurance and taxes).
• Lease term covers a large portion of the useful life of
the leased property.
• Lessee’s payments to the lessor are sufficient to
discharge the lessor’s payments to the lender.
Bona Fide Lease Transactions
1. The term should be less than 30 years,
otherwise the lease may be regarded as a form
of sale.
2. The rent should represent a reasonable return to
the lessor.
3. The renewal option should be bona fide.
4. There should be no purchase option, or if there
is one, the lessee should merely be given parity
with an equal outside offer.
LEASING VS. OWNERSHIP
There are three major alternatives to finance an
asset:
1. A lease agreement
2. An installment sales contract
3. A term loan secured by a mortgage
LEASING VS. OWNERSHIP
Total advantage to be derived from an alternative
depends on:
1. interest expense,
2. depreciation,
3. investment tax credit
4. time value of money
5. potential capital gain due to higher salvage
value.
Nevertheless, in many cases, the advantages of
leasing may outweigh ownership.
Cost of Capital Tied up in Purchase
In other techniques of financing an asset may cost
less than leasing, but capital is tied up in property
acquisition.
For a growth company, any money freed by leasing
(instead of purchasing) may earn a high rate of
return.
Balance Sheet Implications of Leasing
Two possibilities exist to maximize financial leverage
through leasing under operating leases:
1. It is possible for firms to obtain more money for
longer terms under a lease agreement than
under a secured loan agreement for the
acquisition of the asset.
2. Leasing may not have as much of an impact on
future borrowing as would current borrowing.
Balance Sheet Implications of Leasing
Firm X -Purchase
Assets Capital & Liabilities
Before After Before After
Assets 200 300 Debt
Equity
100
100
200
100
Total 200 300 200 300
Firm X -Firm Y - Lease
Assets Capital & Liabilities
Before After Before After
Assets 200 200 Debt
Equity
100
100
100
100
Total 200 200 200 100
Accounting for Leases: Lessee’s Standpoint
Leases treated in 2 ways
1. Capital Leases i.e. purchase of assets
2. Operating Leases (all other leases)
Criteria for Capital Lease
• Transfer of ownership at the end of term
• Lease contract contains a bargain purchase option
(price < fair market value at option date)
• Term is >= 75% estimated economic life of
property
• {PV of lease payments- executor costs}>= 90% of
the excess of fair value of the leased property
Issues Relating To Accounting For Leases
Fair Value:
• Fair value is defined as the price for which
property could be sold in an arm’s-length
transaction between unrelated parties.
• It is the normal selling price (less discount) of a
manufacturer/dealer and cost for the non-
manufacturer/non-dealer.
• It is determined at the inception of the lease.
Issues Relating To Accounting For Leases
• The estimation of fair value is important because:
- It is needed to calculate interest rate implicit
in the lease, residual value, bargain renewal
option, bargain purchase option.
- Fair value becomes the upper limit on the
amount the lessee may record as an asset for
a capital lease.
Issues Relating To Accounting For Leases
Economic Life:
• The economic life of a property is defined as the
estimated remaining period during which the
property is expected to be economically usable, by
one or more users, with normal repairs and
maintenance.
• The estimation of economic life is important
because it is one of the criteria used to classify
lease. Also it has an impact on the residual value.
Issues Relating To Accounting For Leases
• The economic life of the leased property is limited
by the use for which it was intended at the
inception of the lease. (Number of users is not
important.)
Issues Relating To Accounting For Leases
Residual Value:
• The residual value of the leased property is the
estimated fair value of the property at the end of
the lease term.
• Lessee requires the residual value to determine
the implied interest rate.
• Lessor records the estimated residual value as
part of its gross investment in the lease.
Issues Relating To Accounting For Leases
• Sometimes, residual value is difficult to estimate
because of the unpredictability of future events.
 As a result, interest rate charged in leasing
may be below the rates for long-term loans.
- However, the lessee is giving up the tax
benefits arising from depreciation.
 Leasing is primarily advantageous for a
lessee who is unable to use depreciation
deductions and investment tax credits.
TAX ASPECTS OF LEASING
• Tax requirements differ from financial reporting
requirements.
• When the intended lease is treated as a true lease
for tax purpose, the lessor reports the rental
income from lease and the lessee get tax
advantage for the rental payment.
TAX ASPECTS OF LEASING
• If a lease is treated as a sale, the buyer (lessee) is
entitled to get tax deduction for depreciation
expense and interest expense.
- The depreciation expense will be computed
over the useful life of the asset, not over the
lease term.
- The lessee’s basis for depreciation is the sum
of all amounts that represent a part of the
purchase price.
TAX ASPECTS OF LEASING
• When the lease is treated as a conditional sale,
the lessee is entitled to get investment tax credit.
If a conditional sale is deemed to have occurred:
- Lessor must show any gain realized on the
sale
- Required to report interest income,
- Not entitled to a deduction for depreciation.
Tax Effects of a Sale and Leaseback:
• Because funds are tied up in ownership of assets, a
firm may decide to sell the property and lease it
back.
• Also, some people may place the property in trust for
his/ her children and lease it back. This is called gift
and leaseback.
Criteria for Tax Advantage
Sale and leaseback or gift and leaseback may provide
some tax advantages. These transactions will not be
recognized if these are done for tax avoidance. Three
criteria have been employed in making this
determination:
a. Lack of Equity Interest: The taxpayer cannot
hold title or equitable interest in the property.
Keeping a reversionary interest has been
construed to represent an equity interest.
Criteria for Tax Advantage
b. Business Purpose: A business purpose must be
present, with the sale being grounded in economic
reality. Whether the rent paid is reasonable, is
considered in determining a legitimate business
transaction.
c. Independent Trustee: In assessing the good faith
of a gift to a trust and subsequent leaseback, the
independence of trustee is a crucial factor. Tax
deductions will not be allowed if the control
remains in the hands of the donor.
Conditions that must be fulfilled
to treat leveraged lease as a true
lease:
1. Minimum At-Risk Investment
The lessor must have a minimum at risk investment
in the property and that will continue from the
beginning through the end of the lease term.
2. No Bargain Purchase Option
No member of the lessee group may have a
contractual right to purchase the property at less
than the fair market value.
Conditions that must be fulfilled
to treat leveraged lease as a true
lease:
3. No Investment/Lending by Lessee Group
No member of the lessee group can invest in the
property or lend money to the lessor towards the
purchase.
4. Profit Motive
Lessor must expect a profit from the transaction
apart from any tax advantages.
Leasing

More Related Content

What's hot (20)

Leasing–regulatory framework
Leasing–regulatory frameworkLeasing–regulatory framework
Leasing–regulatory framework
 
Lease finance-presentation
Lease finance-presentationLease finance-presentation
Lease finance-presentation
 
Types of leasing by maninder singh
Types of leasing by maninder singh Types of leasing by maninder singh
Types of leasing by maninder singh
 
Factoring
FactoringFactoring
Factoring
 
Lease and hire purchase
Lease and hire purchaseLease and hire purchase
Lease and hire purchase
 
Credit rating
Credit ratingCredit rating
Credit rating
 
Debt securitisation
Debt securitisationDebt securitisation
Debt securitisation
 
Leasing
LeasingLeasing
Leasing
 
Leasing
LeasingLeasing
Leasing
 
Financial services
Financial servicesFinancial services
Financial services
 
Leasing
LeasingLeasing
Leasing
 
Factoring and forfaiting
Factoring and forfaitingFactoring and forfaiting
Factoring and forfaiting
 
Factoring ppt
Factoring pptFactoring ppt
Factoring ppt
 
Swaps
SwapsSwaps
Swaps
 
Factoring
FactoringFactoring
Factoring
 
Forward and futures - An Overview
Forward and futures - An OverviewForward and futures - An Overview
Forward and futures - An Overview
 
Banker & Cuctomer Relationship
Banker & Cuctomer RelationshipBanker & Cuctomer Relationship
Banker & Cuctomer Relationship
 
Negotiable Instruments Act, 1881
Negotiable Instruments Act, 1881Negotiable Instruments Act, 1881
Negotiable Instruments Act, 1881
 
Financial derivatives ppt
Financial derivatives pptFinancial derivatives ppt
Financial derivatives ppt
 
Security Analysis And Portfolio Managment
Security Analysis And Portfolio ManagmentSecurity Analysis And Portfolio Managment
Security Analysis And Portfolio Managment
 

Similar to Leasing (20)

Ib&amp;fs module 6
Ib&amp;fs module 6Ib&amp;fs module 6
Ib&amp;fs module 6
 
CHAPTER 15.pptx
CHAPTER 15.pptxCHAPTER 15.pptx
CHAPTER 15.pptx
 
Lease accounting
Lease accountingLease accounting
Lease accounting
 
Leasing & Hire purchase, factoring & forfeiting and venture capital
Leasing & Hire purchase, factoring & forfeiting and venture capitalLeasing & Hire purchase, factoring & forfeiting and venture capital
Leasing & Hire purchase, factoring & forfeiting and venture capital
 
Leasing 130119075852-phpapp01
Leasing 130119075852-phpapp01Leasing 130119075852-phpapp01
Leasing 130119075852-phpapp01
 
lease accounting and its types
lease accounting and its typeslease accounting and its types
lease accounting and its types
 
Leasing
LeasingLeasing
Leasing
 
Lease presentation
Lease presentationLease presentation
Lease presentation
 
LEASE & ITS TYPES
LEASE & ITS TYPESLEASE & ITS TYPES
LEASE & ITS TYPES
 
Itm.leasing
Itm.leasing Itm.leasing
Itm.leasing
 
Lease presentation 130224081525-phpapp01
Lease presentation 130224081525-phpapp01Lease presentation 130224081525-phpapp01
Lease presentation 130224081525-phpapp01
 
Lease and It's Types..(Assignment)
Lease and It's Types..(Assignment)Lease and It's Types..(Assignment)
Lease and It's Types..(Assignment)
 
Vietnam Accounting Standards - VAS 06 Leases
Vietnam Accounting Standards - VAS 06 LeasesVietnam Accounting Standards - VAS 06 Leases
Vietnam Accounting Standards - VAS 06 Leases
 
Equipment Leasing Basics
Equipment Leasing BasicsEquipment Leasing Basics
Equipment Leasing Basics
 
Leasing and hire purchase are both financial arrangements.
Leasing and hire purchase are both financial arrangements.Leasing and hire purchase are both financial arrangements.
Leasing and hire purchase are both financial arrangements.
 
Lease financing
Lease financingLease financing
Lease financing
 
Leasing
LeasingLeasing
Leasing
 
BASFIN2: Quiz 2 Reviewer
BASFIN2: Quiz 2 ReviewerBASFIN2: Quiz 2 Reviewer
BASFIN2: Quiz 2 Reviewer
 
Ppt of term loan
Ppt of term loanPpt of term loan
Ppt of term loan
 
Asset finance explained
Asset finance explainedAsset finance explained
Asset finance explained
 

More from Maksudul Huq Chowdhury (16)

Strategic Role of HR
Strategic Role of HRStrategic Role of HR
Strategic Role of HR
 
International Human Resources Management
International Human Resources ManagementInternational Human Resources Management
International Human Resources Management
 
Strategic Management and Strategic HRM
Strategic Management and Strategic HRMStrategic Management and Strategic HRM
Strategic Management and Strategic HRM
 
Financial Statement Analysis and Financial Models
Financial Statement Analysis and Financial ModelsFinancial Statement Analysis and Financial Models
Financial Statement Analysis and Financial Models
 
Corporate Finance: Basic Concept
Corporate Finance: Basic ConceptCorporate Finance: Basic Concept
Corporate Finance: Basic Concept
 
Capital structure basic concepts
Capital structure basic conceptsCapital structure basic concepts
Capital structure basic concepts
 
Fundamentals of foreign exchange market
Fundamentals of foreign exchange marketFundamentals of foreign exchange market
Fundamentals of foreign exchange market
 
Monetary policy of bangladesh
Monetary policy of bangladeshMonetary policy of bangladesh
Monetary policy of bangladesh
 
Mutual funds
Mutual fundsMutual funds
Mutual funds
 
Commercial banks
Commercial banksCommercial banks
Commercial banks
 
Primary market and secondary market
Primary market and secondary marketPrimary market and secondary market
Primary market and secondary market
 
Bond markets
Bond marketsBond markets
Bond markets
 
Rules of classification provision rescheduling_write-off
Rules of classification provision rescheduling_write-offRules of classification provision rescheduling_write-off
Rules of classification provision rescheduling_write-off
 
Money Market
Money MarketMoney Market
Money Market
 
Interest Rate Theory
Interest Rate TheoryInterest Rate Theory
Interest Rate Theory
 
Overview of Financial Market, Institution and System
Overview of Financial Market, Institution and SystemOverview of Financial Market, Institution and System
Overview of Financial Market, Institution and System
 

Recently uploaded

How to Add a New Field in Existing Kanban View in Odoo 17
How to Add a New Field in Existing Kanban View in Odoo 17How to Add a New Field in Existing Kanban View in Odoo 17
How to Add a New Field in Existing Kanban View in Odoo 17Celine George
 
Ultra structure and life cycle of Plasmodium.pptx
Ultra structure and life cycle of Plasmodium.pptxUltra structure and life cycle of Plasmodium.pptx
Ultra structure and life cycle of Plasmodium.pptxDr. Asif Anas
 
5 charts on South Africa as a source country for international student recrui...
5 charts on South Africa as a source country for international student recrui...5 charts on South Africa as a source country for international student recrui...
5 charts on South Africa as a source country for international student recrui...CaraSkikne1
 
How to Show Error_Warning Messages in Odoo 17
How to Show Error_Warning Messages in Odoo 17How to Show Error_Warning Messages in Odoo 17
How to Show Error_Warning Messages in Odoo 17Celine George
 
How to Manage Cross-Selling in Odoo 17 Sales
How to Manage Cross-Selling in Odoo 17 SalesHow to Manage Cross-Selling in Odoo 17 Sales
How to Manage Cross-Selling in Odoo 17 SalesCeline George
 
Patient Counselling. Definition of patient counseling; steps involved in pati...
Patient Counselling. Definition of patient counseling; steps involved in pati...Patient Counselling. Definition of patient counseling; steps involved in pati...
Patient Counselling. Definition of patient counseling; steps involved in pati...raviapr7
 
Education and training program in the hospital APR.pptx
Education and training program in the hospital APR.pptxEducation and training program in the hospital APR.pptx
Education and training program in the hospital APR.pptxraviapr7
 
Human-AI Co-Creation of Worked Examples for Programming Classes
Human-AI Co-Creation of Worked Examples for Programming ClassesHuman-AI Co-Creation of Worked Examples for Programming Classes
Human-AI Co-Creation of Worked Examples for Programming ClassesMohammad Hassany
 
PISA-VET launch_El Iza Mohamedou_19 March 2024.pptx
PISA-VET launch_El Iza Mohamedou_19 March 2024.pptxPISA-VET launch_El Iza Mohamedou_19 March 2024.pptx
PISA-VET launch_El Iza Mohamedou_19 March 2024.pptxEduSkills OECD
 
Practical Research 1 Lesson 9 Scope and delimitation.pptx
Practical Research 1 Lesson 9 Scope and delimitation.pptxPractical Research 1 Lesson 9 Scope and delimitation.pptx
Practical Research 1 Lesson 9 Scope and delimitation.pptxKatherine Villaluna
 
How to Make a Field read-only in Odoo 17
How to Make a Field read-only in Odoo 17How to Make a Field read-only in Odoo 17
How to Make a Field read-only in Odoo 17Celine George
 
The Singapore Teaching Practice document
The Singapore Teaching Practice documentThe Singapore Teaching Practice document
The Singapore Teaching Practice documentXsasf Sfdfasd
 
P4C x ELT = P4ELT: Its Theoretical Background (Kanazawa, 2024 March).pdf
P4C x ELT = P4ELT: Its Theoretical Background (Kanazawa, 2024 March).pdfP4C x ELT = P4ELT: Its Theoretical Background (Kanazawa, 2024 March).pdf
P4C x ELT = P4ELT: Its Theoretical Background (Kanazawa, 2024 March).pdfYu Kanazawa / Osaka University
 
Maximizing Impact_ Nonprofit Website Planning, Budgeting, and Design.pdf
Maximizing Impact_ Nonprofit Website Planning, Budgeting, and Design.pdfMaximizing Impact_ Nonprofit Website Planning, Budgeting, and Design.pdf
Maximizing Impact_ Nonprofit Website Planning, Budgeting, and Design.pdfTechSoup
 
UKCGE Parental Leave Discussion March 2024
UKCGE Parental Leave Discussion March 2024UKCGE Parental Leave Discussion March 2024
UKCGE Parental Leave Discussion March 2024UKCGE
 
3.21.24 The Origins of Black Power.pptx
3.21.24  The Origins of Black Power.pptx3.21.24  The Origins of Black Power.pptx
3.21.24 The Origins of Black Power.pptxmary850239
 
How to Add Existing Field in One2Many Tree View in Odoo 17
How to Add Existing Field in One2Many Tree View in Odoo 17How to Add Existing Field in One2Many Tree View in Odoo 17
How to Add Existing Field in One2Many Tree View in Odoo 17Celine George
 

Recently uploaded (20)

Finals of Kant get Marx 2.0 : a general politics quiz
Finals of Kant get Marx 2.0 : a general politics quizFinals of Kant get Marx 2.0 : a general politics quiz
Finals of Kant get Marx 2.0 : a general politics quiz
 
How to Add a New Field in Existing Kanban View in Odoo 17
How to Add a New Field in Existing Kanban View in Odoo 17How to Add a New Field in Existing Kanban View in Odoo 17
How to Add a New Field in Existing Kanban View in Odoo 17
 
Ultra structure and life cycle of Plasmodium.pptx
Ultra structure and life cycle of Plasmodium.pptxUltra structure and life cycle of Plasmodium.pptx
Ultra structure and life cycle of Plasmodium.pptx
 
5 charts on South Africa as a source country for international student recrui...
5 charts on South Africa as a source country for international student recrui...5 charts on South Africa as a source country for international student recrui...
5 charts on South Africa as a source country for international student recrui...
 
How to Show Error_Warning Messages in Odoo 17
How to Show Error_Warning Messages in Odoo 17How to Show Error_Warning Messages in Odoo 17
How to Show Error_Warning Messages in Odoo 17
 
How to Manage Cross-Selling in Odoo 17 Sales
How to Manage Cross-Selling in Odoo 17 SalesHow to Manage Cross-Selling in Odoo 17 Sales
How to Manage Cross-Selling in Odoo 17 Sales
 
Patient Counselling. Definition of patient counseling; steps involved in pati...
Patient Counselling. Definition of patient counseling; steps involved in pati...Patient Counselling. Definition of patient counseling; steps involved in pati...
Patient Counselling. Definition of patient counseling; steps involved in pati...
 
Education and training program in the hospital APR.pptx
Education and training program in the hospital APR.pptxEducation and training program in the hospital APR.pptx
Education and training program in the hospital APR.pptx
 
Human-AI Co-Creation of Worked Examples for Programming Classes
Human-AI Co-Creation of Worked Examples for Programming ClassesHuman-AI Co-Creation of Worked Examples for Programming Classes
Human-AI Co-Creation of Worked Examples for Programming Classes
 
PISA-VET launch_El Iza Mohamedou_19 March 2024.pptx
PISA-VET launch_El Iza Mohamedou_19 March 2024.pptxPISA-VET launch_El Iza Mohamedou_19 March 2024.pptx
PISA-VET launch_El Iza Mohamedou_19 March 2024.pptx
 
Practical Research 1 Lesson 9 Scope and delimitation.pptx
Practical Research 1 Lesson 9 Scope and delimitation.pptxPractical Research 1 Lesson 9 Scope and delimitation.pptx
Practical Research 1 Lesson 9 Scope and delimitation.pptx
 
How to Make a Field read-only in Odoo 17
How to Make a Field read-only in Odoo 17How to Make a Field read-only in Odoo 17
How to Make a Field read-only in Odoo 17
 
The Singapore Teaching Practice document
The Singapore Teaching Practice documentThe Singapore Teaching Practice document
The Singapore Teaching Practice document
 
Personal Resilience in Project Management 2 - TV Edit 1a.pdf
Personal Resilience in Project Management 2 - TV Edit 1a.pdfPersonal Resilience in Project Management 2 - TV Edit 1a.pdf
Personal Resilience in Project Management 2 - TV Edit 1a.pdf
 
P4C x ELT = P4ELT: Its Theoretical Background (Kanazawa, 2024 March).pdf
P4C x ELT = P4ELT: Its Theoretical Background (Kanazawa, 2024 March).pdfP4C x ELT = P4ELT: Its Theoretical Background (Kanazawa, 2024 March).pdf
P4C x ELT = P4ELT: Its Theoretical Background (Kanazawa, 2024 March).pdf
 
Maximizing Impact_ Nonprofit Website Planning, Budgeting, and Design.pdf
Maximizing Impact_ Nonprofit Website Planning, Budgeting, and Design.pdfMaximizing Impact_ Nonprofit Website Planning, Budgeting, and Design.pdf
Maximizing Impact_ Nonprofit Website Planning, Budgeting, and Design.pdf
 
UKCGE Parental Leave Discussion March 2024
UKCGE Parental Leave Discussion March 2024UKCGE Parental Leave Discussion March 2024
UKCGE Parental Leave Discussion March 2024
 
3.21.24 The Origins of Black Power.pptx
3.21.24  The Origins of Black Power.pptx3.21.24  The Origins of Black Power.pptx
3.21.24 The Origins of Black Power.pptx
 
How to Add Existing Field in One2Many Tree View in Odoo 17
How to Add Existing Field in One2Many Tree View in Odoo 17How to Add Existing Field in One2Many Tree View in Odoo 17
How to Add Existing Field in One2Many Tree View in Odoo 17
 
Prelims of Kant get Marx 2.0: a general politics quiz
Prelims of Kant get Marx 2.0: a general politics quizPrelims of Kant get Marx 2.0: a general politics quiz
Prelims of Kant get Marx 2.0: a general politics quiz
 

Leasing

  • 2. LEASING Leasing is a typical financing arrangement. It is an agreement which allows one party to use the asset without having the title of it. From an economic perspective, leasing can be defined as “a contract between two parties where one party (the lessor) provides an asset for usage to another party (the lessee) for a specified period of time, in return for specified payments” (Fletcher et. al., 2005). This is also reflected in accounting-related definitions: According to the Accounting Standard IAS 17 “a lease is an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time”.
  • 3. LEASING Leasing is referred to as asset based financing. As lessors retain ownership of the assets they lease throughout the life of the contract, these leased assets are therefore an inherent form of collateral in such contracts. Conventional bank lending focuses on the loan repayment by the borrower from two sources: a primary source, the cash flow generation, and a secondary source, credit enhancements and collateral. Leasing is focused on the lessee’s ability to generate cash flows from the business operations to service the lease payments, as the lessor retains legal ownership of the asset.
  • 4. LEASING Hence, leasing separates the legal ownership of an asset from its economic use. Ownership of the asset may or may not pass to the customer at the end of the lease contract. Contracts, where legal ownership of the asset passes directly to the customer at the start of the agreement, are not considered to be leases.
  • 5. Parties of Leasing There are two parties: Lessor : Owner of the asset at the beginning of the contract Lessee : User of the asset.
  • 6. Why Do We Go for Leasing 1. Facilitates the acquisition of needed equipment. 2. Makes available funds that would otherwise be tied up in the ownership of fixed assets. 3. Possible tax advantages. 4. Possible improvement of the statement of financial position (B/S).
  • 7. Types of Leasing Four most important types: 1. Operating/Service lease, 2. Financial/Net lease, 3. Sale and lease back and 4. Combination lease.
  • 8. Operating/Service Lease 1. Provides for both financing and maintenance 2. Not fully amortized. Lessor expects to recover all costs from subsequent renewal payments or residual values on disposal. 3. Often gives the lessee the right to cancel the lease before term. 4. Lessor bears the risk of obsolescence. 5. Used for both customized equipment/asset and standard equipment/asset.
  • 9. Financial/Net Lease 1. Does not provide for maintenance service. 2. Not cancelable. 3. Generally fully amortized. Added rent to the lessor. 4. Lessee bears the risk of obsolescence. 5. The lease happens through a leasing company buying a new equipment chosen by the lessee. 6. Used for Standard type of equipment/asset.
  • 10. Sale and Leaseback 1. Under a sale and leaseback, a firm that owns a property sells it to another firm and simultaneously executes an agreement to lease the property back for a stated period. 2. An alternative to a mortgage. 3. Considered as a special type of financial lease.
  • 11. Combination Lease It combines some features of different types of lease.
  • 12. Leasing Credit Criteria, Terms & Rates Lease financing techniques and terms differ depending on: • the lessor, • the length of lease, • the equipment or assets leased and • the prevailing interest rate.
  • 13. Leasing Credit Requirement The standards of granting lease are similar to lending • But less stringent than borrowing. • Lessor is interested in: a. Financial condition of lessee and b. Other pertinent business information. • Generally leasing companies are less restrictive than bank with respect to documentation and financial strength of lessee. • Primary considerations of a leasing company a. Intrinsic value of the equipment b. Marketability of equipment c. Cash flow of lessee
  • 14. Length of Lease Period • Length of lease period is between 2 years and 10 years in majority cases. • Leases for less than 3 years are usually for rolling stock (trucks, forklifts etc.) and office equipments (computers, photocopiers etc.).
  • 15. What can be done after the expiry of lease terms? Three alternatives for the lessee: • New lease with a new asset. • Purchase the property from lessor for residual value. • Renew the lease for residual rent.
  • 16. Alternatives after Lease Period • New Lease with New Asset is the right choice when the asset is rapidly changing in cost and efficiency (e.g. computers get obsolete). • Purchase the Property at a Residual Value (Original Cost + Interest) – (Rents Paid) - FASB defines residual value as the fair market value at the end of lease term. - No set practices determining the residual purchase prices, but typically 10% of original cost is charged.
  • 17. Alternatives after Lease Period • Purchase the Property at a Residual Value (Continued) - The use of fixed purchase price option may prevent classification of lease agreement a true lease for tax purpose. Thus it may remove some of the depreciation and investment credit options available to lessor. • Renew the lease at reduced rent: This option would be exercised if doubt remained about whether to purchase the asset. - Generally, renewed leases require reduced rent (2-5% of original list price) - Sometimes renewed leases incorporate declining rent.
  • 18. Lease Rates • Lease rates vary widely depending on the risks involved. • More specialized the equipment, higher the risk. • Longer lease term, higher the risk to the lessor. • Often Add-on-Interest method is applied in determining lease rates.  Add-on-percentage is multiplied by the contract term (in years) to get the total charge. For example, 5% add-on interest for Tk.200,000 in 6 year lease. Add-on-amount = (6 x 5% of 200,000) = Tk.60,000 Total Charge = 200,000 + 60,000 = 260,000 The add-on is often quoted as a separate increment to the contract.
  • 19. Lease Rates  Sometimes, lease rate is quoted as a certain percentage of original cost per month. For example, 2% of the cost of equipment per month is approximately equal to 5% add-on). For an asset of Taka 200,000, monthly rent = Taka 4,000 When the lessee has high credit rating, lease agreement may be written on a simple interest basis.  Companies with substantial taxable income sometimes enter into leasing business to get depreciation and investment tax credit.
  • 20. Lease Rates  As a result, interest rate charged in leasing may be below the rates for long-term loans. - However, the lessee is giving up the tax benefits arising from depreciation.  So, leasing is primarily advantageous for a lessee who is unable to use depreciation deductions and investment tax credits.
  • 21. Reserve and Setup Charge Lessee required to put up a lease deposit equal to first and last month’s rent (lease payment) for each year of the contract life. If lenient, lessor might charge 2 months’ rent + setup charge or security deposit.
  • 22. TAX ASPECT OF LEASING To determine the type and character of tax deductions, a lessee must determine whether the lease agreement is a true lease or a conditional sales contract. - If the agreement is a true lease, the lessee may deduct rental payments for tax purpose. If the agreement is a conditional sales contract the payments will be considered payments for the purpose of acquiring the property and deductions will be allowed for depreciation and possibly interest expense.
  • 23. Conditional Sales Contract A lease agreement is called conditional sales contract if it meets any of the following conditions. 1. Portions of the periodic payments are specifically applicable to an equity to be acquired by the lessee. 2. Title will be acquired upon payment of a stated amount of rentals. 3. The total payments required for a relatively short period of use constitute an excessively large fraction of the total amount required for having the title of the asset.
  • 24. Conditional Sales Contract 4. The agreed rental payments materially exceed the current fair market rental value for the same asset. 5. The property may be acquired under a purchase option or the price is relatively small when compared to the total payments the lessee is required to make.                      termlease theofendat the propertyofValue option purchase underPrice
  • 25. Conditional Sales Contract 6. Some portion of the periodic payment is specifically designated as interest or is otherwise readily recognizable as the equivalent of interest. 7. Title will be acquired on payment of aggregate amount that approximates the initial sales price, plus interest and carrying charges at which the lessee could have purchased the equipment when entered into the agreement.               chargescarryinginterest priceSalesInitial Amount Aggregate
  • 26. Leveraged Leases Leveraged leases involve three parties – lessor, lessee and a lender to the lessor. Usually these leases are financial leases (Lessee covering maintenance, insurance and taxes). • Lease term covers a large portion of the useful life of the leased property. • Lessee’s payments to the lessor are sufficient to discharge the lessor’s payments to the lender.
  • 27. Bona Fide Lease Transactions 1. The term should be less than 30 years, otherwise the lease may be regarded as a form of sale. 2. The rent should represent a reasonable return to the lessor. 3. The renewal option should be bona fide. 4. There should be no purchase option, or if there is one, the lessee should merely be given parity with an equal outside offer.
  • 28. LEASING VS. OWNERSHIP There are three major alternatives to finance an asset: 1. A lease agreement 2. An installment sales contract 3. A term loan secured by a mortgage
  • 29. LEASING VS. OWNERSHIP Total advantage to be derived from an alternative depends on: 1. interest expense, 2. depreciation, 3. investment tax credit 4. time value of money 5. potential capital gain due to higher salvage value. Nevertheless, in many cases, the advantages of leasing may outweigh ownership.
  • 30. Cost of Capital Tied up in Purchase In other techniques of financing an asset may cost less than leasing, but capital is tied up in property acquisition. For a growth company, any money freed by leasing (instead of purchasing) may earn a high rate of return.
  • 31. Balance Sheet Implications of Leasing Two possibilities exist to maximize financial leverage through leasing under operating leases: 1. It is possible for firms to obtain more money for longer terms under a lease agreement than under a secured loan agreement for the acquisition of the asset. 2. Leasing may not have as much of an impact on future borrowing as would current borrowing.
  • 32. Balance Sheet Implications of Leasing Firm X -Purchase Assets Capital & Liabilities Before After Before After Assets 200 300 Debt Equity 100 100 200 100 Total 200 300 200 300 Firm X -Firm Y - Lease Assets Capital & Liabilities Before After Before After Assets 200 200 Debt Equity 100 100 100 100 Total 200 200 200 100
  • 33. Accounting for Leases: Lessee’s Standpoint Leases treated in 2 ways 1. Capital Leases i.e. purchase of assets 2. Operating Leases (all other leases)
  • 34. Criteria for Capital Lease • Transfer of ownership at the end of term • Lease contract contains a bargain purchase option (price < fair market value at option date) • Term is >= 75% estimated economic life of property • {PV of lease payments- executor costs}>= 90% of the excess of fair value of the leased property
  • 35. Issues Relating To Accounting For Leases Fair Value: • Fair value is defined as the price for which property could be sold in an arm’s-length transaction between unrelated parties. • It is the normal selling price (less discount) of a manufacturer/dealer and cost for the non- manufacturer/non-dealer. • It is determined at the inception of the lease.
  • 36. Issues Relating To Accounting For Leases • The estimation of fair value is important because: - It is needed to calculate interest rate implicit in the lease, residual value, bargain renewal option, bargain purchase option. - Fair value becomes the upper limit on the amount the lessee may record as an asset for a capital lease.
  • 37. Issues Relating To Accounting For Leases Economic Life: • The economic life of a property is defined as the estimated remaining period during which the property is expected to be economically usable, by one or more users, with normal repairs and maintenance. • The estimation of economic life is important because it is one of the criteria used to classify lease. Also it has an impact on the residual value.
  • 38. Issues Relating To Accounting For Leases • The economic life of the leased property is limited by the use for which it was intended at the inception of the lease. (Number of users is not important.)
  • 39. Issues Relating To Accounting For Leases Residual Value: • The residual value of the leased property is the estimated fair value of the property at the end of the lease term. • Lessee requires the residual value to determine the implied interest rate. • Lessor records the estimated residual value as part of its gross investment in the lease.
  • 40. Issues Relating To Accounting For Leases • Sometimes, residual value is difficult to estimate because of the unpredictability of future events.  As a result, interest rate charged in leasing may be below the rates for long-term loans. - However, the lessee is giving up the tax benefits arising from depreciation.  Leasing is primarily advantageous for a lessee who is unable to use depreciation deductions and investment tax credits.
  • 41. TAX ASPECTS OF LEASING • Tax requirements differ from financial reporting requirements. • When the intended lease is treated as a true lease for tax purpose, the lessor reports the rental income from lease and the lessee get tax advantage for the rental payment.
  • 42. TAX ASPECTS OF LEASING • If a lease is treated as a sale, the buyer (lessee) is entitled to get tax deduction for depreciation expense and interest expense. - The depreciation expense will be computed over the useful life of the asset, not over the lease term. - The lessee’s basis for depreciation is the sum of all amounts that represent a part of the purchase price.
  • 43. TAX ASPECTS OF LEASING • When the lease is treated as a conditional sale, the lessee is entitled to get investment tax credit. If a conditional sale is deemed to have occurred: - Lessor must show any gain realized on the sale - Required to report interest income, - Not entitled to a deduction for depreciation.
  • 44. Tax Effects of a Sale and Leaseback: • Because funds are tied up in ownership of assets, a firm may decide to sell the property and lease it back. • Also, some people may place the property in trust for his/ her children and lease it back. This is called gift and leaseback.
  • 45. Criteria for Tax Advantage Sale and leaseback or gift and leaseback may provide some tax advantages. These transactions will not be recognized if these are done for tax avoidance. Three criteria have been employed in making this determination: a. Lack of Equity Interest: The taxpayer cannot hold title or equitable interest in the property. Keeping a reversionary interest has been construed to represent an equity interest.
  • 46. Criteria for Tax Advantage b. Business Purpose: A business purpose must be present, with the sale being grounded in economic reality. Whether the rent paid is reasonable, is considered in determining a legitimate business transaction. c. Independent Trustee: In assessing the good faith of a gift to a trust and subsequent leaseback, the independence of trustee is a crucial factor. Tax deductions will not be allowed if the control remains in the hands of the donor.
  • 47. Conditions that must be fulfilled to treat leveraged lease as a true lease: 1. Minimum At-Risk Investment The lessor must have a minimum at risk investment in the property and that will continue from the beginning through the end of the lease term. 2. No Bargain Purchase Option No member of the lessee group may have a contractual right to purchase the property at less than the fair market value.
  • 48. Conditions that must be fulfilled to treat leveraged lease as a true lease: 3. No Investment/Lending by Lessee Group No member of the lessee group can invest in the property or lend money to the lessor towards the purchase. 4. Profit Motive Lessor must expect a profit from the transaction apart from any tax advantages.