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7/29/2019 Types of Leases
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LEASES A lease is a form of financing under which the owner of an asset (the lessor)
temporarily transfers the right to use, and sometimes other ownership rights andobligations, of an asset to another party (the lessee).
Leasing became a common financing tool after 1973 in India.
Lease financing denotes procurement of assets through lease.
Leasing industry plays an important role in the economic development of a
country by providing money incentives to lessee.
BENEFITS OF LEASING - LESSEE
It provides an alternative to ownership.
The party that leases also benefits from not having its resources invested in
asset. Higher productivity and profits are derived from productive use of asset, rather
than its ownership.
Leasing provides an important financing alternative.
Lessees also benefit from a number of tax advantages.
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Types of leases
This type oflease have
economic
characteristics
of asset
ownership
Allows onlyuse of an
asset, doesnt
convey
ownership
The owner of an
asset sells the assetto a party who in turn
leases back the
same asset to the
owner in
consideration of
lease rentals.
Purchased ofan asset being
leased is
financed by a
third party
A firmacquires the
right to use
an asset from
the
manufacturer
directly.
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CAPITAL LEASE Vs OPERATING LEASE
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EFFECT ON FINANCIAL STATEMENTS
Lessee must depreciate the leased
asset and report the expense on the
income statement. Also records
periodic interest expense as it's owed
over the lease term and reports it in the
income statement, in case of capital
lease.
Lessee records rent paid on an
operating lease in the income statement
as a reduction of sales.
Income Statement for XYZ Ltd.
Sales 100000
COGS 60000Gross Profit 40000
Salaries 12000
Depreciation on Leased Asset 5000
Interest Expense on Lease 2000
Insurance 1000
Water & Electricity 3000
Tax expense 3000
Net Income 26000
Income Statement for PQR Ltd.
Sales 100000
COGS 60000Gross Profit 40000
Salaries 12000
Stationary 2500
Advertising 1000
Insurance 1000
Water & Electricity 3000
Tax expense 3000
Net Income 29500
Income Statement for ABC Ltd.
Sales 100000
COGS 60000
Gross Profit 40000
Salaries 12000
Interest Expense on Lease 3500
Advertising 1000
Insurance 1000
Water & Electricity 3000
Tax expense 3000
Net Income 28500
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Advantages of leasing SAVING OF CAPITAL
Leasing covers the full cost of the equipment used in the business by providing100% finance. The lessee is not to provide or pay any margin 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 in respect 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 business from 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.