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Differences Between Lease Types

Introduction

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11 views3 pages

Differences Between Lease Types

Introduction

Uploaded by

Christian
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

INTRODUCTION

Nowadays, if you want to use an asset, you don’t need to purchase it


from the seller. There are many offers whereby, you can use the asset
just by paying the price for using it, such as Hire Purchasing and
Leasing. The former is a business deal in which the purchaser of the
asset, pays a small amount at the beginning and the rest of the price
in installments. On the contrary, the latter is an agreement between
two parties in which the lessor purchases the asset and permits the
lessee, use the asset for the payment of monthly rentals. Both Hire-
Purchase and Lease are the commercial arrangement, whereby the
asset does not require the customer to own the asset for using it, but
they are not one and the same. The fundamental differences and
similarities between Hire-Purchaing and Leasing are discussed in this
work.
Classification of Lease

According to AS-19 the lease may be of two types:

 Operating Lease
 Financial Lease

Operating Lease: A lease is classified as an operating lease if the


lessor does not transfer all risks and rewards incidental to ownership
of the asset. The lessee acquires rights to use the assets on a period
to period basis. In other words, operating lease covers the period
which is much shorter than the economic life of the asset. The lessor
may lease the asset to different lessees one after another throughout
its useful life. The rent payable by any one lessee during the lease
period is not sufficient to cover cost of the asset fully. At the expiry of
term of lease, the asset reverts back to the lessor. Hence, such leases
are called short term leases. An operating lease is also termed as
„Service Lease‟ because lessor also provides necessary services
relating to insurance, repairs and maintenance of the leased asset.
Therefore, the lease rentals of an operating lease also include for
such services in respect of leased [Link] operating lease is
generally cancelled by either party. Because of provisions of services
along with the risk of obsolescence, the operating lease is more
expensive as compared to other form of lease as the lessee has to
compensate to the lessor for both- the instant services and the risk of
obsolescence.

Finance Lease: According to AS-19, a finance lease is a lease that


transfers substantially all the risks and wards incidental to ownership
of an asset. It usually covers the full useful life of the asset or a period
which is closer to its economic life. Such lease are termed as long-
term or non cancellable lease contract during which the lessor
receives rental that covers not only the cost of the asset but a
reasonable return on the funds invested to acquire the asset. The
repairs and maintenance of the leased asset is undertaken by the
lessee. Hence, such leases are also known as capital or full pay out
leases. At the end of lease term, the asset may be returned to owner
(lessor) or handled as per lease terms.
Advantages of lease Form of business financing

Common questions

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In a hire purchase agreement, the purchaser assumes responsibility for the asset’s risks and maintenance over installments, whereas leasing agreements like operating leases involve the lessor handling maintenance and related risks . In finance leases, although risks are transferred to the lessee, the initial asset cost is recovered by the lessor through lease payments .

In hire purchase, the payment structure involves an initial down payment followed by installments, leading the user towards eventual ownership, thus influencing decisions favoring asset purchase strategies . In contrast, leasing, typically involving monthly rentals without ownership transfer, guides asset users to focus on cash flow management and flexibility, reflecting a predisposition to strategic asset usage without ownership .

Operating leases do not transfer all risks and rewards of ownership to the lessee, and are typically shorter in duration than the asset's economic life. They often include service provisions like insurance and maintenance, and are cancellable by either party . In contrast, finance leases transfer substantially all risks and rewards to the lessee and usually cover the asset's full useful life. These leases are long-term, non-cancellable, and the lessee assumes responsibilities for maintenance .

Asset reversion allows lessors to re-lease assets multiple times, maximizing return on investment across the asset's life span . This influences lessor strategies to focus on asset maintenance, market diversification in lessee types, and optimized scheduling to quickly transition between lessees, ensuring minimal idle periods .

The non-cancellable nature of a finance lease reduces risk for the lessor by ensuring a stable revenue stream throughout the asset's useful life, while transferring maintenance responsibility and asset depreciation risk to the lessee . For lessees, this requires a greater commitment and assumption of typically longer-term risks, aligning more closely with asset ownership despite not owning the asset .

Service provisions in operating leases increase the cost for lessees, as they cover additional expenses like insurance and maintenance, compensating the lessor for the service and obsolescence risk . For lessors, including service provisions can enhance the attractiveness of the lease, lead to repeated business, and help mitigate asset-related risks by maintaining its condition .

For the lessor, a short-term lease period means potential repeated leasing opportunities to different lessees, thereby spreading the cost recovery over multiple short leases . For the lessee, this arrangement provides flexibility and reduced commitment but typically involves higher costs due to service provisions and the lessor’s need to cover insurance and obsolescence risks .

Operating leases provide flexibility through short-term commitments compared to capital assets, but at a higher cost due to additional service provisions . Lessees should evaluate their cash flow, asset utility needs, and risk tolerance. Strategic considerations might include negotiating service terms, aligning lease durations with business cycles, and evaluating cost-benefit comparatives with finance leases .

Offering insurance and maintenance services in operating leases creates a competitive edge by enhancing lease appeal and offering convenience to lessees . Leasing companies might differentiate themselves through service quality and efficiency, potentially allowing for higher pricing that reflects the bundled services while also mitigating lessee concerns about asset management .

An asset's economic life is pivotal in structuring leases. In operating leases, the lease period is much shorter than the asset's economic life, allowing the lessor to lease the asset to multiple parties over its lifespan . Conversely, finance leases span the entirety or close to the full economic life of the asset, ensuring that the lessee pays for the asset's full value over the lease term .

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