Unit – 4

Leasing and

Higher Purchase

MFIS

Introduction

In addition to debt and equity financing, leasing has emerging s third important source of intermediate and long term financing of corporate enterprises

during the last few decades.

Meaning of Leasing

Lease is a contractual arrangement in which a party

owing an asset/equipment (lessor) provides the assets for use to another/transfer the right to use the equipment to the user (lessee) over a certain period of time for the consideration of return of periodic payment (rental) with or

without a further payment (premium).

At the end of the period of contract the asset/equipment is reverts back to the lessor unless there is a provision for the renewal of the contract.

Leasing is an arrangement that provides a firm with used and control over assets without buying and owing the same. It is a form of renting

assets.

Lease is a contract between the owner of the asset (lesser) and the user of the asset called lessee, whereby the lesser gives the right to use the asset to the lessee over an agreed period of time for a consideration called the lease rental.

The lease contract is regulated by the terms and conditions of the agreement.

In long term lease contracts, the lessee is generally given an option to buy or renew the

lease.

Elements of Lease Financing

1. Parties to the contact,2. Asset3. Ownership separate from the users4. Term of lease5. Lease rentals

Modes of Terminating Lease

1. The lessor sells the asset to the lessee.

2. The asset give back to the lessor.

3. The lease renewed on a perpetual basis for a specific period.

Types of Leasing

1. Operating or Service Lease

In this lease the lessor does not transfer all the risks and rewards incidental to the ownership of the asset and the cost of the asset is not fully amortized during the primary lease period.

The lessor provides services attached to the leased assets, such as maintenance, repair and technical advice.

For this reason, operating lease is also called ‘service lease’. Operating lease is generally used for computers, office equipments, automobiles, trucks, some other equipments, telephones, and so on.

Characteristics of Operating Lease

1. It is short term lease.

2. The lease is usually cancelable at short-notice by the lessee.

3. The lessor is generally for maintenance, insurance and taxes of the asset.

4. The lessee has the option of renewing the lease after the expiry of lease period.

2.Financial Lease

A lease is classified as financial lease if it ensures the lessor for amortization of the entire cost of investment plus the expected return on capital outlay during the term of the lease.

Such a lease is usually for a longer period of time and non-cancelable.

As a source of funds, the financial lease is an alternative similar to debt-financing.

Most of the lease in India are financial leas that are commonly used for leasing land, building, machinery and fixed equipment.

Characteristics of Financial Lease

1. The PV of the total lease rentals payable during the period of the lease exceeds or is equal to the whole of the fair value of the leased assets.

2. Financial is for long period of time.

3. It is usually non-cancelable by the lessee prior to its expiration date.

4. The lessee is generally responsible for the maintenance, insurance and service of the asset.

3. Sale and Lease back and Direct Lease

Under the sale and lease back lease, a firm may sell an asset which it already owns to another party and lease it back from the buyer.

The lessee receives immediate cash for his assets and repays the lease rentals over the stipulated period.

In Direct lease, the lessee and the owner of the equipment are two different entities.

4. Single investor lease and leverage lease

In Single investor lease, only two parties to the lease transaction, the lessor and the lessee. The leasing

company (lessor) funds the entire investment by an appropriate

mix of debt-equity funds.

The debt raised by the leasing company to finance the asset

are without resources to the lessee. In the case of default

in servicing the debt by the leasing company the lender is

not entitled to payment from the lessee.

Leveraged lease- in it , there are three parties involved- lessor (leasing company), lessee

(user of the equipment), and financer.

Leasing company contribute through the way of equity capital, financial institution, and banks finance by way of term loans towards the purchase of an asset to be leased.

5. Domestic Lease and International Lease

Domestic Lease- A lease is said to be a domestic lease if all parties t the

transaction are domiciled in the same country.

International Lease- If the parties involved

in the leasing transaction are located in two

different nations, the transaction is known

as international lease transaction.

EVOLUTION OF LEASING

Leasing activity was initiated in India in 1973.

The first leasing company of India was set up in that year by Farouk Irani, with industrialist AC Muthia for several years, and the company

‘First Leasing Company of India Ltd’.

Meaning / Definition

Hire purchase is hiring an asset for a period of time and at the end of the period,

purchasing the same. This is time sharing of the asset.

The person hiring the asset acquires its possession and the right to use it .

As a legal device it is being used for financing of capital goods such as industrial finance, financing of consumer goods and for selling consumer good on hire purchase.

To be valid HP, agreements must be in writing and signed by both the parties. They must clearly lay Out the following information in written form:-

• A clear description of the goods• The cash price for the goods• The deposit of Amount• The monthly installments• The right of the hire to terminate the contract

when he feels like doing so with a valid reason.• The HP price (the total sum that must be paid to

hire and then purchase the goods)

Parties Involved in Hire purchase

There are two parties involved in a hire purchase contract, namely the intending seller and the intending buyer or hirer.

Now a days hire purchase contract involves three

parties, namely –

The Seller,The Financier, The Hirer.

1. Seller

The seller is the (hiree) who agrees to part

with the possession of the goods to the buyer (hirer) for a consideration which

will be spread over a specific period of time.

2. Buyer

The purchaser or the buyer is also known as

hirer who purchases the goods on hire purchase from the seller agreeing to

pay the value of the goods in regular installments spread over a specific

period of time.

3. Financer

In most of the hire purchase contracts there are only two parties; the seller and the buyer but in certain rare cases there may be a third party, the hire purchase financer, who pays the price of the goods to the seller on behalf of the buyer and then collects the dues along with interest from the buyer of the goods.

A dealer now normally arranges a hire purchase agreement through a finance company with the customer.

It is therefore, a tripartite deal.

The finance (hire purchase) company purchases the equipment from the supplier and gives it on hire.

The hirer is required to make a down payment of 20-25% of the cost and pay the balance amount along with the interest in EMI, in advance or arrears over a time span of 36-48 months.

Alternately, the hirer has to deposit an equal amount as a fixed deposit with the finance company which provides the entire finance on hire purchase terms, repayable with interest in EMIs over 36-48 months.

Deposit and the accumulated interest is returned to the hirer upon payment of the last installment.

Ownership

Hire Purchase - The ownership of the equipment passes to the hirer on payment of the last installment. The lessor company is the owner and The lessee is entitled only to the use of the leasedequipment.

Hire Purchase - Depreciation The hirer is entitled depreciation shield on the assets hired by him.

Hire Purchase - To the Depreciation on the asset is charged in the books of the lessor. Tax Benefits Hirer is

HIRE PURCHASE

Me a n in g / D e fi n itio n

Hire purchase is hiring an asset for a period of time and at the end of the period,

purchasing the same. This is time sharing of the asset.

The person hiring the asset acquires its possession and the right to use it .

As a legal device it is being used for financing of

capital goods such as industrial finance, financing of consumer goods and for selling consumer good on hire purchase.

Parties involve in hire purchasing

• Lessor

• Lessee

• Financer (third party)

Conditions to

protect the parties

• The hirer will be allowed to enjoy quiet possession of the goods, i.e. no-one will interfere with the hirer's possession during the term of this contract.

• The owner will be able to pass title to, or ownership of, the goods when the contract requires it.

• That the goods are of merchantable quality

and fit for their purpose, save that exclusion clauses may, to a greater or lesser extent, limit the Finance Company's liability.

The Hirer usually has the following rights:-

• To buy the goods at any time by giving notice to the owner and paying the balance of the HP price less a rebate.

• To return the goods to the owner — this is subject to the payment of a penalty to reflect the owner's loss of profit.

• Where the owner wrongfully repossesses the goods, either to recover the goods plus damages for loss of quiet possession or to damages representing the value of the goods lost.

• Basically hirer have following rights- 1. Rights of protection 2. Rights of notice 3. Rights of repossession 4. Rights of Statement 5. Rights of excess amount

The Hirer usually has the following obligations:

• To pay the hire installments

• To take reasonable care of the goods (if the hirer damages the goods by using them in a non-standard way, he or she must continue to pay the installments and, if appropriate, compensate the owner for any loss in asset value)

• To inform the owner where the goods will be kept.

• A hirer can sell the products if an only if he has purchased the goods finally.

The owner's rights

• The owner usually has the right to terminate the agreement where the hirer defaults in paying the installments or breaches any of the other terms in the agreement. This entitles the owner:

• To forfeit the deposit

• To retain the installments already paid and recover the balance due

• To repossess the goods (which may have to be by application to a Court depending on the nature of the goods and the percentage of the total price paid)

• To claim damages for any loss suffered.