There are two The parties to a
parties to a lease: hire purchase
the owner called agreement are
the lessor and the the hire
user called the purchaser (the
lessee. The lessor is buyer) and the
the person who hire vendor
owns the asset and (the seller)
gives it on lease.
The lessee takes the
asset on lease and
uses it for the
period of the lease.
Ownership is no
pre-condition for
leasing
Hire purchase involves the gradual payment of installments by the hirer, leading to ownership transfer at the end, while leasing
entails periodic payments for the use of an asset without ownership transfer, with options to return, extend, or asset purchase
at the end of the lease term
Some of the key disadvantages of hire purchase agreements
include the overall higher cost of the product and the fact that
ownership is not transferred until all payments are made.
These agreements can also be very complex arrangements with
a lot of paperwork, which can cause people to spend beyond
their means. There is also the potential for loss if the goods are
returned
Hire purchase agreements are used to pay for very expensive
consumer goods so that the buyer doesn't have to outlay a
large amount of cash in one go. Though hire purchase
agreements do include payment installments plus interest, they
are not considered an extension of credit. They can be a
manageable way for buyers to purchase expensive goods but
the goods end up costing more because of the interest
Basis for Comparison Financial Lease Operating Lease
A commercial contract in which the lessor lets A commercial contract where the lessor
1. Meaning the lessee use an asset instead of periodical allows the lessee to use an asset in place
payments for the usually long period. of periodical payments for a small period;
3. Transferability The ownership is transferred to the lessee. The ownership remains with the lessor.
4. The term of the lease It is a contract for the long term. It is a contract for a short term.
The contract is called a loan The contract is called the rental
5. Nature of contract agreement/contract. agreement/contract.
In the case of an operating lease, the
In the case of a financial lease, the lessee would
6. Maintenance need to take care of and maintain the asset.
lessor would need to take care of and
maintain the asset.
7. Risk of obsolescence It lies on the part of the lessee. It lies on the part of the lessor.
In the case of an operating lease, the
Usually, during the primary terms, it can’t be
8. Cancellation done; but there can be exceptions.
cancellation can be made during the
introductory period.
The expenses for the asset, such as depreciation
Even the lease rent deduction from the
9. Tax advantage and financing, are allowed for a tax deduction to
tax is allowed.
a lessee.
In a financial lease, the lessee gets an option to
In an operating lease, the lessee is not
10. Purchasing option purchase the asset he has taken on a lease for a
given any such option.
price less than asset’s fair market value.
EVALUATION OF LEASE TRANSACTION
EVALUATION OF LEASE TRANSACTION
Evaluating a lease transaction involves financial and operational implication
for both the lessor(the owner of asset) and the lessee (the user of asset)
The evaluation answer the question
1. Ensuring the lease arrangement is beneficial for both the parties
2. Allign with financial and operational goals
1. Financial Evaluation
2. Operational Evaluation
3. Risk Assessment
4. Legal and Contractual Evaluation
5. Strategic Fit
EVALUATION OF LEASE TRANSACTION
Operational Evaluation Financial Evaluation
Asset Use and Flexibility Cost - Benefit Analysis
• Asset Utilization • Total Cost of leasing
• Flexibility • Present value of lease payments
• Residual Value
Maintenance and Operational Cost Impact on Financial Statements
• Responsibility for maintenance • Balance Sheet Impact
• Operational Efficiency • Income Statement Impact
• Cash Flow Impact
Tax Impllications
• Tax Deductibility
• Depreciation and Interest Deduction
Operational Evaluation
• Asset Utilization
• Flexibility
• Maintenance and Operational Cost
• Responsibility for maintenance
• Operational Efficiency
EVALUATION OF LEASE TRANSACTION
Risk Assessment Legal and Contractual Evaluation
Market Risk Review of Lease Terms
• Residual Value Risk • Lease Agreement Clauses
• Interest Rate Risk • Compliance with Regulations
Ownership and Transfer Rights
Credit Risk • Ownership Rights
• Lessee creditworthiness • Sub – leasing and Transferability
• Lessor’s Financial stability
Startegic Fit
Allignment with Business Strategy
• Long Term Asset Strategy
• Impact on Capital Structure
Competitive Advantage
• Access to Advanced Technology
• Scalability
