Leasing Nad Hire Purchase

7/31/2019 Leasing Nad Hire Purchase

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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

Documents

Leasing Nad Hire Purchase