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Presented By:
Priyanka jaiswal
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TOPICS COVERED.1. Leasing & Parties Involved
2. Types Of Lease Agreements.
3. Accounting Standards
4. Difference between IAS 17 and AS19
5. Tax Implications.
6. Advantages Of Leasing.
7. Leasing Industry Status In India.8. Challenges Faced By The Industry.
9. Hire Purchase concept.
10.Outcome of contract termination.
11.Evaluation Of Hire Purchase.
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LEASING:
A lease is a transaction in which a party owing an asset provides the asset for
the use over a certain period of time to another party for consideration either
in form of periodic rent and/or in form of down payment.
Lease financing is based on the observation made by Donald B. Grant: Why
own a cow when the milk is so cheap? All you really need is milk and not the
cow.
Parties Involved:
Lessor
Lessee
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TYPES OF LEASE AGREEMENTS
Lease agreements are basically of two types.
They are:
(a) Financial lease -Also known as Capital Lease, Long-term Lease, Net Leaseand Close Lease. It is like an installment loan. In a financial lease, the lessee
selects the equipments, settles the price and the term of sales and arranges
with a leasing company to buy it. He enters into a irrevocable and non-cancellable agreement with the leasing company. Land & building, office
equipments, heavy machinery are leased.
(b) Operating lease - Also known as Service Lease, Short-term Lease orTrue Lease. It is like a rental agreement. In this lease, the contractual
period between the lessor and lessee is less than full expectedeconomic life of equipment. Contract period ranges from intermediate
to short-term. Contracts are usually cancellable either by the lessor or
by the lessee. Computers, automobiles, mines etc. are leased.
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TYPES OF LEASE AGREEMENTS Contd
The other variations in lease agreements are :
(c)Sale and lease back - Under this type of lease, a firm which has anasset sells it to the leasing company and gets it back on lease. The asset isgenerally sold at its market value. The sale and lease back agreement is
beneficial to both mlessor and lessee.
Sale and lease back transaction issuitable for those assets, which are not subjected depreciation butappreciation, say land. Retail stores, shopping centers, etc. are financedunder this method.
(d) Leveraged leasing- A leverage lease is used for financing those assetswhich require huge capital outlay. The leverage lease agreement involves
three parties, the lessee, the lessor and the lender. The loan is generallysecured by mortgage of the asset besides assignment of the leased rentalpayments. In leveraged lease, a wide range of equipments such as rail road,coal mining, pipe lines, ships, etc. are acquired.
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TYPES OF LEASE AGREEMENTS Contd
(e) Cross Border Lease:Also known as International Leasing, andTransnational Leasing. It relates to a lease transaction between a lessor andlessee domiciled in different countries and includes exports leasing. In other
words, the lessor may be of one country and the lessee may be of another
country.
(f) Direct Leasing: Under direct leasing, a firm acquires the right to usean asset from the manufacturer directly. The ownership of the asset leased out
remains with the manufacturer itself. The major types of direct lessor include
manufacturers, finance companies, independent lease companies, special
purpose leasing companies etc
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To identify if a lease is operating or finance we must look at how the risks and
rewards are transferred.
To determine whether the risks and rewards of ownership have been
transferred to the lessee, at least one of the following four (4) criteria must be
met.
1) The Lease transfers title of the assets to
the lessee by the end of the lease term.
2) The Lease term is 75% or more ofthe
useful life of the Asset period over which
the leased asset is expected to be used bythe lessee.
3) The Lease contains a Bargain Purchase
Option (BPO) - This option allows the lessee
to purchase the leased asset for an amountsubstantially lower than the expected FMV
at the end of the Lease
4) The Present Value (PV) of the minimum
lease payments (MLP) is 90% or more of the
Fair Market Value (FMV).
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ACCOUNTING
STANDARDS
AS 19 (issued in 2001)
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AS 19 is applicable to accounting for all leases other than :
Lease agreement to explore natural resources such as oil, gas.Timber, metal & other mineral rights.
Licensing agreements for motion picture film, video recording,
Plays, manuscripts, patents & other rights.
Lease agreement to use land.
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In case of FINANCIAL LEASES in the books of lessee
1. The lessee recognize the lease as an asset and a liability
at an amount equal to the fair value of the leased assets
but if fair value > Present value of minimum lease payments then,
at Present value of minimum lease payments.
(Present value to be calculated with discount rate equal to interest rate implicit in
the lease OR the lessee's incremental borrowing rate).
2. The lessee may also have to pay other related asset expenses e.g.
Insurance and/or Property Taxes.
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3. Depreciation:
When the lessee is sure of acquiring the ownership of the asset by the end of
the lease period, the asset is depreciated over the period of expected use (i.e.
the useful life) of the asset.
Useful life can be:
a. The period over which the leased asset is expected to be used.
b. The number of production expected to be obtained from the use of the asset
by the lessee.
When the lessee is not sure of acquiring the ownership of the asset by the
end of the lease period, the asset is to be depreciated over the lease term
or useful life whichever is lower.
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4. Compulsory disclosures to be made by the lessee in his books:
asset acquired under the finance lease as segregated from the asset owned;
for each class of assets, the net carrying amount at the balance sheet date;
a reconciliation between the total of the lease payments at balance sheet
date and their present value.
Contingent rents recognized as expense in P/L account of the lessee;
the total of future minimum sub-lease payments expected to be received
under non-cancellable sub-leases at balance sheet date;
a general description of lessees significant lease arrangements.
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In case of FINANCIAL LEASES in the books of lessor
1) The lessor should recognize the asset given under lease in its Balance sheet as
receivable at an amount equal to the net investment in the lease.
2) The lease payment receivable is treated by the lessor as repayment of the
priniple amount i.e. the net investment in the lease.
3) The lease payments relating to the accounting period, excluding cost of
services, and reduced from both the principal and the unearned finance
income.
4) Initial direct costs, such as commissions and legal fees, are often incurred bythe lessors are either recognized immediately in the statement of profit and
loss or allocated against finance income over lease term.
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5) Compulsory disclosures to be made by the lessee in his books
- the total gross investment in the lease and the PV of MLP receivable atbalance sheet date.
- unearned finance income
- the unguaranteed residual values accruing to the benefit of the lessor..- any contingent rent receivable recognized in P/L statement of the
lessor.
- accounting policy adopted in respect of initial direct cost.
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In case of OPERATING LEASES in the books of lessee
1) Lease payments should be recognized as an expense in the statement of P/L account
on a straight line basis over the lease term.
2) The lessee should also make the following disclosures in his books:
- the total of future minimum lease payments under non-cancellable operating
leases;
- the total of future minimum sub-lease payments expected to be received undernon-cancellable sub-leases at the balance sheet date;
- lease payments recognized in the statement of profit and loss for the period, with
separate amounts for minimum lease payments and contingent rent;
- sub-lease payments received (or receivable) recognized in the statement of P/L
account for the period;
3) A general description of lessees significant leasing agreement including
determination of contingent rents, renewal or purchase option, escalation clauses,
restrictions imposed etc
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In case of OPERATING LEASES in the books of lessor
1) The asset given under lease should be presented in the lessors balance
sheet as fixed asset.
2) Costs, including the depreciation incurred in earning the lease as well as all
the incomes (excluding the receipts for services such as insurance and
maintenance) are recognized in the P/L account.
3) Initial direct costs incurred to earn lease are either deferred and allocated to
income over the lease term in proportion to the rent income,
OR, are recognized as expense in income statement in the period in which
they occur.
4) The depreciation should be on a basis with normal depreciation policy of the
lessor and Accounting Standard 6 should be used for calculations.
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Sale & lease back
Accounting treatment If lease back is finance lease
1) Any profit or loss of sale proceeds over the carrying amount should not be
immediately recognized as profit or loss in the financial statements of a
seller-lessee
2) It should be deferred & amortized over lease term in proportion to the
depreciation of leased asset.
Accounting treatment If lease back is operating lease
1) Any profit or loss arising out of sale transaction is recognized immediately.
If the Sale Price is below the fair value: Profit Recognize profit immediately
Loss- Recognize loss immediately, provided loss is not compensated by
future lease payment
Loss Defer & amortize loss, if loss compensated by future lease payment.
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If sale price above fair value
If carrying amount is equal to fair value which will result in profit, amortizethe profit over lease period
Carrying amount less than fair value will result in profit - amortize & defer theprofit equal to sale price less fair value & recognize balance profit immediately
Carrying amount more than fair value will result in loss equal to(carrying amount less than fair value) should be recognized immediately. Profitequal to selling price less fair value should be amortized.
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Significantdifferences between AS 19 and IAS-17
AS-19 is not applicable to lease agreement to use land whereas IAS-17 is
applicable to lease agreement to use land.
AS 19 specifically prohibits upward revision in estimate of unguaranteed
residual value during the lease term, however IAS 17 does not prohibit the
same.
As per IAS 17, the initial direct cost incurred by the lessor other than
manufacturer or dealer lessor have to be included in the amount of lease
receivable in case of finance lease resulting in reduced amount of income to be
recognized over lease term and in the carrying amount of the asset in the case of
operating finance as to expense it over to lease term on the same basis as leaseincome.
where as in AS19 these can be charged off at the time of incurrence in the
statement of P&L or can be amortized over the lease period.
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IAS 17 specifically provides that the standard shall not be applied on the
basis of measurement for :
Property held by lessees that is accounted for as investment
property.
Investment property provided by the lessor under operating leases.
Biological assets held by lessees under financial leases or.
Biological assets provided by lessor under operating leases.
However AS19 does not exclude this above from its scope.
Significant differences continued.
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TAX IMPLICATIONS
Lease rentals
are subjected toTax.
Tax on thesalvage value ofthe assetowned.
LESSOR
Lease rentalsare tax-deductibleexpenses.
Depreciation taxshield
OR
Tax on interest
LESSEE
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ADVANTAGES OF LEASING
Saving of capital: Leasing covers the full cost of the equipment used in the
business by providing 100% finance. The lessee is not to provide or pay anymargin money as there is no down payment. In this way the saving in capital
or financial resources can be used for other productive purposes e.g. purchase
of inventories.
Flexibility and Convenience: The lease agreement can be tailor- made inrespect of lease period and lease rentals according to the convenience and
requirements of all lessees.
Planning Cash flows: Leasing enables the lessee to plan its cash flows
properly. The rentals can be paid out of the cash coming into the businessfrom the use of the same assets.
Improvement in liquidity: Leasing enables the lessee to improve their
liquidity position by adopting the sale and lease back technique.
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LEASING INDUSTRY STATUS IN INDIA
SREI International
Finance
Sundaram Finance
Cholamandalam Finance
Mahindra & Mahindra
GE Capital
Present industry order Only few major players exist.
Shriram Finance
Tata Finance
Countrywide
Finance
Citicorp
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CHALLENGES BEFORE THE INDUSTRY
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Rising competition from
banks:
Unequal competition from Banks& MNCsCost of Funds.
No focused / dedicated Recovery
Mechanismsuch as DRTs/recovery officers etc.
TDS on interest payments to
NBFCs Not applicable to banks.
NBFC Stigma Credibility issues ,
Industry brand image.
Funding and Regulatory
issues:
Poor availability of medium and
long term funding.
Multiplicity of taxes - Sales tax /
Service tax / Entry tax on lease
transactions.
Multiple Regulators - Lack of
Comprehensive Legislation.
Although right of repossession of
assets recognized there are
impediments in implementation
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OPPORTUNITIES TO THE INDUSTRY
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Large Potential
Average annual growth rate of more
than 30%
Large variety of user segment
Presently, there are above 400
leasing players in India; about 10%
operate on large scale.
Number of lessors in India exceeds
the number of leasing players in US.
High growth potential in Vehicle
Finance:
Commercial Transportation
Govt. support, Diverse products New Products - Dealer Finance,
Working Capital Finance, Personal
Loans.
Expansion Opportunities:
Huge infrastructure spending in next5yrs (approx Rs 3,60,000 crores)
Steadily rising disposable income
Generating huge demand for
consumer goods
Global opportunities Cross-Border
Leases allowed
Substantially reduced dependence on
public deposits
as a source of fund
Comparatively Low Default Rate
Particularly in consumer loans and vehicles
financing
http://www.economist.com/node/215431
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HIRE PURCHASE
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CONCEPT AND MEANING OF HIRE PURCHASE
Hire Purchase is an agreement according to which the hire-purchase (hirer)agrees to take goods on hire at a stated rental with an option to purchase.
The hire purchase system is regulated by the Hire Purchase Act 1972.
This Act defines a hire purchase as an agreement under which goods are leton hire and under which the hirer has an option to purchase them in
accordance with the terms of the agreement and includes an agreement
under which:
The owner delivers possession of goods thereof to a person on condition
that such person pays the agreed amount in periodic installments.
2) The property in the goods is to pass to such person on the payment of
the last of such installments, and
Such person has a right to terminate the agreement at any time before
the property so passes.
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OUTCOME OF CONTRACT TERMINATION
Return the asset
Pay the future instalments.
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EVALUATION OF HIRE PURCHASE
Cost of Hire Purchase is defined as (COHP)
COHP= Immediate Payment (Down Payment) + PV of hiring charges
(instalments) + PV of service charges PV of depreciation tax shield PV of
net salvage value.
From hirers angle, the NPV of a hire purchase (NPV(HP)) is as follows:
NPV(HP)= (-) Cost of the asset- initial costs+ PV of HP instalments- PV of tax
on interest component of HP instalments + PV of tax shield on initial costs.
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THANK YOU