Types and Examples of Leasing

Leasing is an old method of financing which is now gaining popularity almost in whole world. Legally, the lease contract is not a sale of the object, but rather a sale of the usufruct (the right to use the object) for a specified period of time. Under it, there are two parties one is the owner or lessor of the asset and other is the lessee or the party that takes the asset on lease. The lessee takes the asset for use for a specified period of time and makes rental payments. The ownership of the asset rests with the lessor but it is in the possession of lessee and right of use is also transferred to lessee.

It has following are different types. The two basic types of leasing are: Finance Lease and Operating Lease. These are explained below:

(1) Finance Lease: Under finance lease all risks and rewards of ownership of asset are transferred to lessee. The ownership or title may or may not be transferred. A finance lease is somewhat like a hire purchase agreement. Under finance lease the lessee after paying agreed number of installments, is entitled to exercise an option to become the owner of asset.

Example:

Suppose the AB company takes a new automobile on lease for three year. Also assume that at the end of three years the AB company will be called to take the ownership of vehicle at no extra cost. Here not only the vehicle is taken on lease but also the AB company is using the lease agreement as a means of financing the automobile. This type is called capital lease or finance lease.

(2) Operating Lease: According to International Accounting Standard (IAS-17) the operating lease is one which is not a finance lease. Under operating lease, the lessor gives the right to lessee to use the asset or property for a specified period of time, but risks and rewards of ownership are retained by the lesser.

Example:

Let up suppose that MY enterprises owns a complete 6th floor in Eden Tower, a multi story building. Further assume that MY enterprises gives some rooms of this floor on lease to XY corporation.

Now if the value of this building increase due to good business activity then the lessor i.e., MY enterprises can take the benefit of this increase by either selling out the rooms or by increasing the rental amount. On the other hand if the building decreases in value than also the MY enterprises will be the sufferer of loss. This type of leasing is called operating lease.

Besides these two main types, some other types of leasing are explained below:

(3) Sale and Lease Back: Under sale and lease back agreement, an asset is first sold to the financial institution. The sale is made at the genuine market value. After that the asset is taken back on a lease. This type of leasing is advantageous for those companies which do not want to show high debt balances in their financial statement.

(4) Capital Lease: This type of leasing is governed by the financial standard board which is not applicable in Pakistan. Under this type, when lessee acquires an asset on lease, he simultaneously recognizes it as a liability in the financial statement.

(5) Leveraged Lease: This type of leasing involves three parties including a lender, a lessor and a lessee. The lender and lessor join hands to accumulate funds to buy the asset. The asset purchased is then given on the lease to lessee. The lessee makes periodic payments to the lessor who in turn makes payment to the lender.

(6) Cross Border Leasing: It means to operate lease agreement in other countries. Such type of leasing is very difficult in present circumstances. The reasons being that different accounting treatments, tax charges and incidental criteria prevail in foreign countries. Also the tax rules differ from country to country. So a big problem arises as how to present such lease agreement in financial statement.

However, as with recent developments the accounting treatments are being made similar for each items all-around the world by International Accounting Standards and it is hoped that cross border leasing will rapidly flourish in near future.