Lease Financing & It's Types

A lease is a contractual agreement whereby one party i.e., the owner of an asset grants the other party the right to use the asset in return for a periodic payment. In the lease financing the asset is given on rent for specified period. The owner of the assets is known as the Lessor. The party whom the asset is given is called the Lessee.  The fixed amount is paid by Lessee to the Lessor for the use of the asset which is known as lease rental.  The lease contract is signed, which stipulates the terms and conditions for regulation of the lease arrangements.  The asset is given back after the expiry of lease period.  This finance may be used for modernisation and diversification of the organisation.  Lease financing may be suitable for the business related to fast changing technological developments. The Lessee shall compare the cost of buying the asset and the cost of leasing the asset for entering to lease financing.

 



Types of Lease

There may be two types of lease financing. These may be finance lease and operating lease.  Let us learn them in detail.

 

a)    Finance Lease: The Lessor transfers substantially all the risks and rewards of ownership of assets to the Lessee for lease rentals. The Lessee is brought in the same condition as he/she would have been if he/she had purchased the asset. There are two phases of finance lease.  The first phase is known as primary phase.  The primary phase is non-cancellable period.  The Lessor recovers his investment through the rent of the lease.  The primary period may last for indefinite period of time. The lease rental for the secondary period is smaller than that of primary period.

 

Features of Finance Lease

1)    In the lease financing, the Lessee gets a right to use an asset.

2)    The Lessor charges lease rent during the primary period of lease. The amount of the lease rent may recover the investment.

3)    The amount of lease rent for secondary period is less.

4)    The maintenance of asset is done by the Lessee.

5)    The Lessor do not take the risk and reward related to asset.

6)    The investment of Lessor is ensured because the lease is non-cancellable.

 

b)    Operating Lease

Lease which is not finance lease is called operating lease. In case of operating lease, the risks and rewards incidental to the ownership of asset are not transferred by the Lessor to the Lessee. The term of such lease is much less than the economic life of the asset.  The Lessee may not recover the total investment through lease rental during the primary period of lease. The Lessor usually provides advice to the Lessee for repair, maintenance and technical know how of the leased asset. Thus, the operating lease is also referred as service lease.

 

Features of Operating Lease

1)    The term of lease is less than  the economic life of the asset.

2)    The Lessee can terminate the lease at a short notice. The penalty is not charged for termination.

3)    The technical know how is provided by the Lessor.

4)    The Lessor bears the risks and rewards.

5)    Lessor gives leasing an asset to different Lessee. The leasing facilitates recovery of investment.

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