What is leasing? The lease is a relatively new method of financing which is gaining popularity almost in whole world Lease simply means to rent or be rented. A lease is a contract letting or renting a house, equipment machinery, or any other durable goods.
Leasing is an agreement between the owner of the asset (Leasor) and the user ( Lessee) who has to make periodic payments to the owner for obtaining the right to use the asset
The following assets are commonly leased:
Cars, computers, equipment, buildings, and plots of land, etc.
Types of Leasing Two basic types of leasing are:
- Finance Lease
- Operating Lease AR
(A) Finance Lease Or Capital Lease
Under finance lease, all risks and rewards of ownership of the asset are transferred to lessee . A finance lease is somewhat like a hire purchase agreement At the end of the lease period. The asset may be purchased by the lessee at the negotiable price.
Suppose the AB company leases a new automobile for three years. Also, assume that at the end of three years the AB company will be called to the ownership of the vehicle at no extra cost. This type of leasing is called a capital lease or finance lease.
(B) Operating Lease
According to international accounting standard 17, the operating lease is one, which is not a finance lease. In other words, under the operating lease, the lessor gives the right to lease to use the asset or property for a specified period of time, but risks and rewards of ownership are retained by the lessor.
Suppose that My enterprises own a complete 6th floor in Eden Tower, a multistory building Further assume that My enterprises give some rooms of this floor in the lease to XY corporation
Now if the value of this building increase due to good business activities then the leasor i.e. My enterprises can take the benefits of this increase by either selling out the room or by increasing the rental amount. On the other hand, if the value of building decreases than also My enterprises will be the sufferer of loss. This type of leasing is called an operating lease.
Other Types of leasing are:
Besides the above, two main types, some other types of leasing are explained below:
Sale and Lease Back:
Under the sale and leaseback agreement; an asset is first sold to the leasing company or financial Institution The sale is made at the genuine market value. After that, the asset is taken back on a lease. This type of leasing is advantageous for those companies. Which do not want to show high debt balances in their financial statement.
This type of leasing involves three parties; a lender, lessor, and lessee. The lender and join hands to accumulate funds to buy The asset. The asset purchased is then given on the lease to hands lessee makes periodic payments to the lessor who in tum makes payment to the lender lessor and lessee.
Cross Border Leasing:
Cross border leasing means to operate a lease agreement in other countries. Such type of leasing is very difficult in present circumstances treatments are being made similar for each item through the world by international accounting However as with recent development the accounting standards it is hoped that cross border leasing would rapidly flourish in near future.
Importance Or Advantages Of Leasing
The lease system of using assets has the following advantages:
Leasing depicts economic sensibility. We know that when we use an asset it depreciates in value. After usage of some years when you sell it, we earn quite less amount as compared to what we spent on acquiring it. So the economists say that we must try to take such an asset on lease which will depreciate in the future. On the other hand, we should buy those assets, which appreciate in value with usage or passage of time.
Money Available For Other Usage:
Money helps you in maintaining your cash flows with the help of leasing an asset that can be acquired without making any heavy cash outflows. In this way, cash is available for meeting other short-term liabilities.
Preservation Of Working Capital:
Leasing helps in preserving working capital and in making your business more sound and productive Leasing keeps your precious working capital in the bank, maintains the balance of your current accounts, and makes the lines of credit available to you for other uses.
No Down Payment:
As against hire-purchase or installment sales. The lease does not acquire making down payment Thus cash is saved that may be invested elsewhere.
Leasing Hedges Against Obsolescence:
The risk of obsolescence of leased asset is averted. When a new invention, model, or an improved product like a computer or cars is introduced into the market the lessee may ask the leasor to replace the did asset with the new one without any extra financial burden.
Saving In Duties And Taxes:
When you purchase an asset you will have to pay duties, taxes, custom payments, etc, in case of leasing you are saved from such payments.