Leasing is defined as a contract between a lessor and a lessee for the hire of a specific asset for a specific period on payment of specified rentals.
The maximum period of lease according to law is for 99 years. Previously land or real estate, mines and quarries were taken on lease. But now a day’s plant and equipment, modem civil aircraft and ships are taken.
Participants in Leasing
- Lessor: The party who is the owner of the equipment permitting the use of the same by the other party on payment of a periodical amount.
- Lessee: The party who acquires the right to use equipment for which he pays periodically.
Types of Leasing
1. Financial Leasing: This type of lease which is for a long period provides for the use of asset during the primary lease period which devotes almost the entire life of the asset. The lessor assumes the role of a financier and hence services of repairs, maintenance etc., are not provided by him. The legal title is retained by the lessor who has no option to terminate the lease agreement.
The principal and interest of the lessor is recouped by him during the desired playback period in the form of lease rentals. The finance lease is also called capital lease is a loan in disguise. The lessor thus is typically a financial institution and does not render specialized service in connection with the asset.
2. Operating Lease: It is where the asset is not wholly amortized during the non-cancellable period, if any, of the lease and where the lessor does not rely for is profit on the rentals in the non- cancellable period. In this type of lease, the lessor who bears the cost of insurance, machinery, maintenance, repair costs, etc. is unable to realize the full cost of equipment and other incidental charges during the initial period of lease.
The lessee uses the asset for a specified time. The lessor bears the risk of obsolescence and incidental risks. Either party to the lease may termite the lease after giving due notice of the same since the asset may be leased out to other willing leases.
3. Sale and Lease Back Leasing: To raise funds a company may-sell an asset which belongs to the lessor with whom the ownership vests from there on. Subsequently, the lessor leases the same asset to the company (the lessee) who uses it. The asset thus remains with the lessee with the change in title to the lessor thus enabling the company to procure the much needed finance.
4. Sales Aid Lease: Under this arrangement the lessor agrees with the manufacturer to market his product through his leasing operations, in return for which the manufacturer agrees to pay him a commission.
5. Specialized Service Lease: In this type of agreement, the lessor provides specialized personal services in addition to providing its use.
6. Small Ticket and Big Ticket Leases: The lease of assets in smaller value is generally called as small ticket leases and larger value assets are called big ticket leases.
7. Cross Border Lease: Lease across the national frontiers is called cross broker leasing. The recent development in economic liberalisation, the cross border leasing is gaining greater importance in areas like aviation, shipping and other costly assets which base likely to become absolute due to technological changes.
Merits of Leasing
- In the leasing deal less documentation is involved, when compared to term loans from financial institutions.
- It is an alternative source to obtain loan and other facilities from financial institutions. That is the reason why banking companies and financial institutions are now entering into leasing business as this method of finance is more acceptable to manufacturing units.
- The full amount (100%) financing for the cost of equipment may be made available by a leasing company. Whereas banks and other financial institutions may not provide for the same.
- The ‘Sale and Lease Bank’ arrangement enables the lessees to borrow in case of any financial crisis.
- The lessee can avail tax benefits depending upon his tax status.
Demerits of Leasing
- In leasing the cost of interest is very high.
- The asset reverts back to the owner on the termination of the lease period and the lesser loses his claim on the residual value.
- Leasing is not useful in setting up new projects as the rentals become payable soon after the acquisition of assets.
- The lessor generally leases out assets which are purchased by him with the help of bank credit. In the event of a default made by the lessor in making the payment to the bank, the asset would be seized by the bank much to the disadvantage of the lessee.