Theoretical & Regulatory Framework of Leasing
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1 Theoretical & Regulatory Framework of Leasing - Asset/Fund based financial services Module III Prof.
2 Contents Concept Elements Classification Advantages and Limitations of Leasing Structuring of Leasing Transactions (Sums) 2
3 Meaning It is an contractual agreement in which a company owning an asset provides the assets for the use to another company for a agreed period of time in consideration. 3
4 Concepts Explained --- The real function of lessor is not renting of asset but lending money. Lessor is the owner of the asset who has given his assets to another person. Lessee is the receiver of the asset who is going to use assets under a lease contract. 4
5 Essential Elements Leasing 1. Parties to contract: Lessor,Lessee, & (Lease financier) 2. Ownership Separated from user 3. Terms(tenure) of Lease: Agreement will inoperative if tenure is not mentioned 4. Lease Rentals 5
6 Classification of Lease 1. Finance & Operating Lease 2. Sales and Lease back AND Direct Lease 3. Single Investor and Leveraged Lease 4. Domestic and International Lease 6
7 1.(a) Finance Lease Meaning : In Finance lease, the assets is being given to lessee on lease for the entire economic life of the assets. E.g. Ship, aircraft, railway wagons etc.. 7
8 In finance lease the lessor transfers substantially all the risks & rewards to lessee. It involves the payment of rentals which is non-cancelable during the lease period. 8
9 IAS-17 stipulates that substantial part of the ownership related risk can be transferred when : Ownership is transferred at the end of lease term The lessee has the option to purchase the asset at a price below the fair market value The lease term is for a major part of the useful life of the asset. (i) Physical Life (ii) Technological Life (iii) Product market Life How to decide that it is a Finance Lease? If the lease term exceeds more than 75 % of useful life of the equipment OR the PV of lease payment together should be atleast 90% of the cost of equipment. 9
10 Structure of Lease Finance 1. Lessee selects the equipment according to its requirement from the manufacturer. 2. The lessee negotiates and settles with the manufacturer. 3. The lessor purchases equipment from manufacturer. 4. The lessor then leases out the equipment to the lessee. (Lessor retains ownership). 10
11 5. A finance lease may provide option to lessee to purchase a equipment at a future date 6. The lease period spreads over the expected economic life of the asset. Lease is originally noncancellable during primary lease period 7. As the equipment is chosen by the lessee, the responsibility of its suitability, risk of obsolescence and liability of repair rest with the lessee 11
12 Operating Lease Meaning : Operating lease is for a term shorter than the useful (economic) life of an asset; Generally, payment during the lease term is less than the lessor s initial cost of the leased asset. 12
13 Lessor provides services such as Maintenance, Repair and Technical advice Also known as, Service Lease Examples of Operating Lease are computers, automobiles etc.. 13
14 Operating Lease is structured with the following features Significantly shorter than the useful life of the leased assets The lease can be cancelable by either party during leasing period. Lease rental are not sufficient to totally amortise the cost of assets Lessor is responsible for the obsolescence of technology. As lease rental can be cancel during the lease period 14
15 2. Sale and Lease Back Owner of the equipment Sales the asset Leasing Company E.g. Safe deposit vault of bank 15
16 Direct Lease The lessee and the owner of the equipment are different entities Two Types : 1. Bipartite Lease 2. Tripartite Lease 16
17 3. Single Investor Lease There are only two parties in the lease transaction : Lessor and Lessee Leasing Companies Equity Debt Without recourse to Lessee 17
18 Leveraged Lease Leasing Company Lender Equity Debt Full Recourse to Lessee 18
19 4. Domestic Lease and International Lease Domestic Lease If all the parties to an agreement (i.e. equipment supplier, Lessor, Lessee) belongs (domiciled) to the same country. International Lease If parties to lease transaction are located in different countries. Import Lease Cross-boarder Lease 19
20 Advantages of Leasing : To the Leessee Financing of Capital Goods Additional Source of Finance Ownership Preserved Avoids Conditionality Flexibility in Structuring of Rentals Obsolescence Risk is Averted 20
21 To the Leessor Full Security Tax Benefit High Profitability High Growth Potential 21
22 Limitations of Leasing Restrictions on use of Equipment Limitations of Financial Lease Loss of Residual Value Understatement of Lessee s Asset Double Sales-tax 22
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