Introduction To Equipment Leasing

CONCEPT & CLASSIFICATION •Contractual agreement (lease contract) •where owner (lessor) transfers right to use the asset to the user (lessee) •Without transferring ownership •for an agreed period of time (lease time) •in return for a rental (lease rental ) •Asset is reverted back unless there is provision of renewal •Aircraft & railway companies in Japan , Canada, US, Germany had shown 4 to 8 % NPV benefit when they took asset on lease instead buying/finance

FINANCE LEASE OR CAPITAL LEASE • Lease where there is transferring a substantial part of Risks & Rewards ( Ex. Obsolescence )associated with ownership from lessor to lease • There is transfer of substantial part of risk & reward if : – Ownership is transferred at end of lease – Option to purchase at lower price than FMV on date of option – Lease term is for major part of life of assets – PV of minimum lease payments greater than or substantially equal to FMV on inception of lease • According to FASB (USA) if lease term exceeds 75 % of useful life or PV of lease payments exceeds 90 % of FMV on date of inception of lease

FINANCE LEASE OR CAPITAL LEASE • Lessee is responsible for repair , maintenance & insurance of assets • Lessee undertakes hell or high water obligation to pay lease rental regardless of condition or suitability of asset • Financial lease which operates over entire economic life of an asset is called as FULL PAY OUT LEASE

PRACTICAL PROBLEM • A company has given an equipment costing 400 lacs on lease for 5 years on lease rental Rs 300/ 1000 PA. Incremental borrowing rate is 18 % . Is the lease a financial lease if useful life is 6 or 10 years ?

SOLUTION A ) 5 / 6 = 83.3 % WHICH IS MORE THAN 75 % • HENCE IT IS FINACIAL LEASE B ) 5 / 10 = 50 % WHICH IS LESS THAN 75 % • BUT • 400 * 300 / 1000 = 120 • 120 * PVIFA ( 18,5) • 120 * 3.127 = 375.24 LACS • 375.24 / 400 = 94 % • WHICH IS GREATER THAN 90 % • HENCE IT IS FINACIAL LEASE

OPERATING LEASE • • • •

IAS defines it as any lease other than Financial lease Lease term significantly less than economic life of asset Lessee enjoys right to terminate lease Technological & business related risk are not shifted from lessor to lessee

• Wet lease - Lessor if provides operating know how , supplies services , undertakes Insurance & maintenance • Dry lease – lessee bears cost of insurance & maintenance • Lessor has to recover investment & return by multiple lease or by realisation of resale value which is difficult to estimate , hence it is not in popular use