FINANCIAL LEASING

What is Financial Leasing?

Financial leasing is a modern financing method that allows individuals to own and make use of
certain assets for medium to long term financing periods in return for previously-set interim
payments.
What does a Finance lease typically entail?
Finance leases typically entail the following:
The lessee, who is the customer or borrower, identifies a given asset (equipment, vehicle,
software, etc.).

The lessor, who is the finance company, purchases the identified asset and becomes its legal
owner.
The lessee, in turn, will be able to use the asset throughout the determined leasing period,
paying a series of rentals or installments for the use of that asset.
At the conclusion of the leasing period, the lessor would have recovered a large portion (or
all) of the initial cost of the identified asset, in addition to interests earned from the rentals or
installments paid by the lessee.
The lessee also has the option to acquire ownership of the identified asset by, for example,
paying the final rental or installment, or by bargaining a final purchase price with the lessor.
Throughout the duration of the leasing period, the lessor (finance company) remains the
legal owner of the asset. However, the lessee also has control over the asset, making use of
the benefits and assuming the risks of economic (defacto) ownership.
What Is the Difference Between Financial Leases and Capital Leases?
Financial and capital leases are particular types of leasing transactions offered to both individuals
and corporations by lending institutions such as banks, credit unions and financial firms to
purchase machinery and equipment. Capital and financial leases offer different payback options
and interest flexibility. Because of their rigidity and tax and insurance requirements, financial
leases are a better option for large, prosperous companies, while capital leases offer flexibility
that factors in both the life of the equipment and the payback term.
Financial Lease
A financial lease is a monetary loan utilized by a corporation to purchase equipment for its
business. These full-payout loans are non-negotiable once enacted, and the lessee, not the
lending institution, is responsible for the maintenance of purchased equipment, as well as all
relevant taxes and insurance necessary for its use. In financial leases, banks merely finance
equipment for business while lessees are responsible for its upkeep.
Capital Lease
Capital leases are similar to financial leases; however, any property purchased through a capital
loan must be recorded as a taxable asset on the lessee's financial records. Whereas financial
leases are non-negotiable once entered into, capital leases offer lessees more flexibility. Capital
leases take into account property life, or the length of time equipment is usable. A capital lease
also takes in account the ownership transfer at the end of the lease term, or rather, the transferal
of the property when the payment plan has been completed. Capital leases also often consider the
value of the property when determining the lease's payments, so lessees don't have to pay more
than the property is worth.
Purchase at Financial Lease End
Under a financial lease, the lessee is offered the option of purchasing the bank-financed
equipment at the termination or conclusion of the lease. Conventionally, this buyout cost is
determined by both parties when entering into the lease agreement. That said, finance leases tend
to be longer than capital leases and most commonly extend into most, if not all, of the useful life
of the equipment. This places an enormous priority on regular equipment maintenance and
upkeep for lessees who enter into financial lease agreements.
Purchase at Capital Lease End
Similar to financial leases, capital leases also offer transfer of equipment ownership when they
expire or are paid off. Conventional contracts ensure that the lease term is equal to 75 percent or
more of the viable life of the property. Stipulations are made at the commencement of capital
leases if the product being purchased is not brand new. Transfer of ownership on equipment
obtained by capital lease is considered complete when the lease rental payments of the loan are
equal to 90 percent or more of the device or equipment's fair market value, as established by an
independent auditor.
Also known as a capital lease, a financial lease is a situation in which a finance company or other
lessor purchases an asset, then leases that asset to a client or lessee for a specified amount of
time. At that point, the client takes possession of the asset and is free to utilize the asset for the
duration of the lease agreement. Once the client has fulfilled the terms of the lease, including
paying any applicable interest, the client usually has the option of purchasing the asset from the
finance company at an extremely low price.
The exact duration of the financial lease will vary, based on the nature of the asset and the terms
agreed upon by the client and the finance company. Some agreements of this type are set up as a
long-term agreement, while others require an intermediate-term. For the life of the lease, the
lessor retains ownership of the asset. The client has full use of the asset, and thus enjoys most of
the benefits of ownership. However, the lessee also assumes many of the responsibilities
associated with ownership, even though the lessor retains that status
One of the easiest ways to understand how a financial lease functions is to consider non-
cancelable lease agreement for a new vehicle. The lessor and the buyer or lessee agree that the
lessee will lease the new vehicle for a series of payments, with one payment due each calendar
month for the duration of the lease. During this period the lessor is still the owner of record, but
the lessee is responsible for the maintenance and most repairs on the vehicle, other than those
specifically addressed in the terms and conditions of the lease. At the end of the lease, the lessee
has the option of buying the vehicle from the lessor, usually for very little, and becoming the full
owner of the car.
This type of commercial arrangement is different from a similar agreement known as an
operating lease. With an operating lease, the lessee has only limited access to the asset; with a
financial lease, the lessee has complete use. In addition, the lessor usually recoups the full
investment, plus a small return, over the life of the financial lease; that is not necessarily the case
with an operational lease, where the lessor may still have an outstanding amount of investment
that has not been recouped.
A capital or financial lease functions according to the regulations put in place in the jurisdiction
where the agreement is established. Different nations set the criteria for what constitutes a lease
of this type. In the United States, a capital lease must meet one of four basic qualifications. The
lease must offer the option of transferring ownership to the lessee at the end of the lease; there
must be a bargain purchase option that is less than the current fair market value of the asset. In
addition, the duration of the lease must be at least equal to 75% of the anticipated useful life of
the asset; and the total value of the lease payments must be at least 90% of the original amount
paid by the lessor to acquire the asset.
Car Leasing Companies on wise GEEK
The representative from the car shipping company will generally provide a form on which any
existing damage to the car will be noted. Choose a car shipping company that has a clear vehicle
damage policy.
For example, in New York City, many high-level executives are offered the service of a car and
driver by their companies. A company may also issue a company car to an employee if a vehicle
is required to perform his job.
Operating versus Capital Leases
Firms often choose to lease long-term assets rather than buy them for a variety of reasons - the
tax benefits are greater to the lessor than the lessees, leases offer more flexibility in terms of
adjusting to changes in technology and capacity needs. Lease payments create the same kind of
obligation that interest payments on debt create, and have to be viewed in a similar light. If a
firm is allowed to lease a significant portion of its assets and keep it off its financial statements, a
perusal of the statements will give a very misleading view of the company's financial strength.
Consequently, accounting rules have been devised to force firms to reveal the extent of their
lease obligations on their books.
There are two ways of accounting for leases. In an operating lease, the lessor (or owner) transfers
only the right to use the property to the lessee. At the end of the lease period, the lessee returns
the property to the lessor. Since the lessee does not assume the risk of ownership, the lease
expense is treated as an operating expense in the income statement and the lease does not affect
the balance sheet. In a capital lease, the lessee assumes some of the risks of ownership and
enjoys some of the benefits. Consequently, the lease, when signed, is recognized both as an asset
and as a liability (for the lease payments) on the balance sheet. The firm gets to claim
depreciation each year on the asset and also deducts the interest expense component of the lease
payment each year. In general, capital leases recognize expenses sooner than equivalent
operating leases.
Since firms prefer to keep leases off the books, and sometimes prefer to defer expenses, there is a
strong incentive on the part of firms to report all leases as operating leases. Consequently the
Financial Accounting Standards Board has ruled that a lease should be treated as an capital lease
if it meets any one of the following four conditions -
(a) if the lease life exceeds 75% of the life of the asset
(b) if there is a transfer of ownership to the lessee at the end of the lease term
(c) if there is an option to purchase the asset at a "bargain price" at the end of the lease term.
(d) if the present value of the lease payments, discounted at an appropriate discount rate, exceeds
90% of the fair market value of the asset.
The lessor uses the same criteria for determining whether the lease is a capital or operating lease
and accounts for it accordingly. If it is a capital lease, the lessor records the present value of
future cash flows as revenue and recognizes expenses. The lease receivable is also shown as an
asset on the balance sheet, and the interest revenue is recognized over the term of the lease, as
paid.
From a tax standpoint, the lessor can claim the tax benefits of the leased asset only if it is an
operating lease, though the revenue code uses slightly different criteria for determining whether
the lease is an operating lease.
When a lease is classified as an operating lease, the lease expenses are treated as operating
expense and the operating lease does not show up as part of the capital of the firm. When a lease
is classified as a capital lease, the present value of the lease expenses is treated as debt, and
interest is imputed on this amount and shown as part of the income statement. In practical terms,
however, reclassifying operating leases as capital leases can increase the debt shown on the
balance sheet substantially especially for firms in sectors which have significant operating leases;
airlines and retailing come to mind.
We would make the argument that in an operating lease, the lease payments are just as much a
commitment as lease expenses in a capital lease or interest payments on debt. The fact that the
lessee may not take ownership of the asset at the end of the lease period, which seems to be the
crux on which the operating/capital lease choice is made, should not be a significant factor in
whether the commitments are treated as the equivalent of debt.
Converting operating lease expenses into a debt equivalent is straightforward. The operating
lease payments in future years, which are revealed in the footnotes to the financial statements for
US firms, should be discounted back at a rate that should reflect their status as unsecured and
fairly risky debt. As an approximation, using the firms current pre-tax cost of debt as the
discount rate yields a good estimate of the value of operating leases. Note that capital leases are
accounted for similarly in financial statements, but the significant difference is that the present
value of capital lease payments is computed using the cost of debt at the time of the capital lease
commitment, and is not adjusted as market rates change.
Islamic leasing

Ijarah is a lease agreement between two parties to the act. The party giving out a particular
asset on lease, effectively the owner of the subject asset is known as the lessor. While, the
party to the agreement that takes up the asset on lease for its use is known as the lessee.
The agreement entails the lessor giving out his asset to the lessee for a period that is specified
in advance. The amount to be paid by the lessee to the lessor, in each installment is also agreed
at the start of the contract. It is also mutually agreed that the lessee would pay the lessor the
residual worth of the asset at the end of the contract. This worth, unlike additional
installments, would be paid in bulk.
All costs related to the asset such as its registration with the relevant authorities before use, its
insurance, should that be required, as well as its maintenance are to be duly taken care of by
the lessee. The lessor has no part to play towards contributing in these costs which have to be
borne out by the lessee entirely.
Also, the agreement, once agreed and started, cannot be revoked. The lessee cannot return the
lessors asset before the agreed on date at which the contract ends. The lessee cannot therefore
avoid later payments to the lessor by virtue of returning the asset at an early date, at will. The
contract is binding on both parties for the duration specified and any party deviating from its
terms can be challenged in a court of law.
The concept of Ijarah is such that it allows a separation of ownership and use of the same
asset(s). This situation poses a number of benefits for both the lessee and the lessor. The lessee
is able to acquire and use an asset of tremendous use and profit to him without paying in bulk
for the purchase of the asset. This is what is different from purchasing the asset outright from
the market. So, the lessee is able to acquire and use the asset with little finances at his end, not
paying anything at the start of the agreement and only paying at regular intervals as he
generates income from the asset or from a secondary source.
Coming to the benefits offered by such an arrangement to the lessor, the lessor does not have
to wait for a buyer to accumulate enough money to purchase his product. He can simply settle
down for a breakup of the total cost of the asset and an agreement that states that he would
receive money against his asset, in installments from the lessee. Also, that the lessee would be
bound to purchase his asset at the end of the contract with the residual value of the asset
being paid like a normal transaction, i.e. in full. This also benefits the lessor in the sense that
he receives a stream of finance without having to wait for it over a long time since fixed assets
require a lot of payment to secure full ownership, an ability not shared by every other buyer in
the market.