Theoretical & Regulatory Framework of Leasing...

Theoretical & Regulatory

Framework of Leasing

- Asset/Fund based financial services

Module III

Prof. Nishant Dhruv, Atmiya College

Nishant Dhruv, Atmiya College

Contents

� Concept

� Elements

� Classification

Advantages and Limitations of Leasing� Advantages and Limitations of Leasing

� Structuring of Leasing Transactions (Sums)

2Nishant Dhruv, Atmiya College

Meaning

� It is an contractual agreement in which a

company owning an asset provides the company owning an asset provides the

assets for the use to another company for a

agreed period of time in consideration.


Concepts Explained ---

� The real function of lessor is not renting of

asset but lending money.

� Lessor is the owner of the asset who has � 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.


Essential Elements Leasing

1. Parties to contract: Lessor,Lessee, & (Lease financier)

2. Ownership Separated from user2. Ownership Separated from user

3. Terms(tenure) of Lease: Agreement will in-operative if tenure is not mentioned

4. Lease Rentals


Classification of Lease

1. Finance & Operating Lease

2. Sales and Lease back AND Direct Lease

Single Investor and Leveraged Lease3. Single Investor and Leveraged Lease

4. Domestic and International Lease


1.(a) Finance Lease

� Meaning :

In Finance lease, the assets is being given to

lessee on lease for the entire economic life of lessee on lease for the entire economic life of

the assets.

E.g. Ship, aircraft, railway wagons etc..


� In finance lease the lessor transfers

substantially all the risks & rewards to lessee.

� It involves the payment of rentals which is � It involves the payment of rentals which is

non-cancelable during the lease period.


� 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 valuethe 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.


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.manufacturer.

3. The lessor purchases equipment from manufacturer.

4. The lessor then leases out the equipment to the lessee. (Lessor retains ownership).


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 non-economic life of the asset. Lease is originally non-

cancellable 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


Operating Lease

Meaning :

� Operating lease is for a term shorter than the

useful (economic) life of an asset; useful (economic) life of an asset;

� Generally, payment during the lease term is

less than the lessor’s initial cost of the leased

asset.


� Lessor provides services such as

Maintenance, Repair and Technical advice

� Also known as, Service Lease� Also known as, Service Lease

� Examples of Operating Lease are computers,

automobiles etc..


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.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


2. Sale and Lease Back

Owner of the equipmentSales the asset

Leasing Company

E.g. Safe deposit vault of bank


Direct Lease

� The lessee and the owner of the equipment

are different entities

� Two Types : � Two Types :

1. Bipartite Lease

2. Tripartite Lease


3. Single Investor Lease

� There are only two parties in the lease

transaction : Lessor and Lessee

Leasing Companies

Equity Debt

Without recourse

to Lessee


Leveraged Lease

� Leasing Company

Lender

DebtEquity

Full Recourse to Lessee


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


Advantages of Leasing :

� To the Leessee

� Financing of Capital Goods

� Additional Source of Finance� Additional Source of Finance

� Ownership Preserved

� Avoids Conditionality

� Flexibility in Structuring of Rentals

� Obsolescence Risk is Averted


� To the Leessor

� Full Security

� Tax Benefit� Tax Benefit

� High Profitability

� High Growth Potential


Limitations of Leasing

� Restrictions on use of Equipment

� Limitations of Financial Lease

� Loss of Residual Value

Understatement of Lessee’s Asset� Understatement of Lessee’s Asset

� Double Sales-tax


Theoretical & Regulatory Framework of Leasing...

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