FINANCIAL LEASE CONTRACT
A financial lease is also called a capital lease. It is the acquiring of assets by means of a lease. It is an arrangement wherein the lessee will choose an asset, the lessor will buy the chosen asset for the lessee, and the lessee will utilize the asset during the period indicated in the lease contract while paying either for rental fees or installments for the privilege of using the asset. The lessor, in turn, will regain the cost or amount of the asset with corresponding interest. The lessee is given the option to transfer ownership to his name or to an organization. This may be in the form of paying the last installment fee, or bargain purchase price.
While the asset is under lease, the legal owner of the leased asset is the finance company. However, the lessee is given control of the leased asset. It happens also that while the lessor finances the asset, and the lessee agrees to the risk involved in the use of the asset, another party owns the asset.
The important aspect of a financial lease contract is the segregation of ownership from its utilization. It is based on Donald B. Grant’s observation of [i]”why own a cow when the milk is so cheap? All you really need is milk and not the cow.”
Lease financing offers lessee capital incentives. The lessee does not have to shell out the total cost of the asset at the time of contract signing. The lessee can practice flexibility based on his needs for financing. The lessee also does not bear obsolescence or devaluation risks of assets.
Financial lease contracts are non-cancellable long-term type of lease contracts. It is irrevocable. All risks and benefits are on the lessee who will carry maintenance, repair, and insurance costs. The lessor will hold the title for ownership of the asset until such time that the lease expires and/or the lessee opted to purchase the asset. Examples of these assets are automobiles, houses, lots, apartments, office spaces, building, etc.
Under the lease agreement, the lessor gains to recoup around ninety percent of the asset’s fair value from rentals while the asset’s commercial life is almost seventy-five percent utilized during the lease period.
In an Operating Lease contract, the lessee is given only a limited use of the asset. The lessor bears the maintenance and upkeep costs. The lessee has no option to buy the asset at the expiration of the lease contract. The agreement is only for a short time frame and revocable even at a short notice. Examples where these lease contracts are used are computer and vehicle or transportation rentals.
A sub-component of financial lease is the Sale and Lease Back. A buyer purchases an asset from an owner, and leases back the asset to the original owner. Under this financial transaction, no exchange of actual asset occurs. Everything is through papers and documents only. This type of financial lease applies only for those assets that appreciates rather than depreciates in the long run, e.g. land. In this agreement, the buyer is the lessor who acquires the lease rentals while the seller is the lessee who obtains the selling price agreed by both parties. In this transaction, there is the possibility that sale at below or above the fair market price be structured and the lease rentals differences be adjusted. This way, the impact on sale of assets, whether profit or loss, will be put off.
Leveraged leasing is an arrangement wherein there is an involvement of a third party. The third party serves as the capitalist or the lender where the lessor will borrow around eighty percent of the cost of purchase of an asset. The asset will then be held as collateral or a security against the loaned amount. Payment from lease rentals will go to the lender. Surplus from the paid lease rentals will go to the lessor. The owner of the asset, who is the lessor, is allowed an allowance due to depreciation of the asset.
Direct leasing obtains the entitlement to utilize an asset directly from the manufacturer. The manufacturers maintain ownership of the leased assets.
In leasing, lessee is provided the advantages of savings on capital, flexibility and convenience, planning cash flows, and improvement in liquidity. The lessee is not required to put up the necessary margin due to the absence of down payments. The capital saved can, in the meantime, be used for other business purposes.
[i] www.du.ac.in
Credit:ivythesis.typepad.com
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