WHAT
IS LEASING?
“Leasing
is a contract between a Lessor and Lessee, giving
the Lessee possession and use of a specific asset
on payment of rentals over a period. The Lessor retains
ownership of the asset so that it never becomes the
property of the Lessee or any other related third
party during the tenure of the lease”. In other
words, an equipment lease is a usage agreement between
an equipment owner (a lessor) and a user of the property
(a lessee). The lessee remits to the lessor a periodic
rental fee as compensation for the usage of the property.
Lease
agreements take the form of written contracts and
specifically set forth the various terms and conditions
of the lease transaction. Such terms and conditions
include:
•
The number of periods the equipment is to be used
• The amount and timing of the lease payments
• The specifications of the equipment leased
and any end-of-term conditions.
TYPES
OF LEASES
In
leasing business, there are basically two major types
of leases and several lease plans that can be contracted
by firms to suit their peculiar circumstances. The
two categories of leases available are the Finance
Lease and the Operating Lease. All other variations
can belong to either one or the other of these two
types.
Finance
Lease
A
finance lease (also known as a Capital or Full Pay-out
Lease) is a contract involving payment over a period
of time (known as the primary or basic period) of
specified sums sufficient in total to amortise the
capital outlay of the lessor and to provide for the
lessor’s cost of funds plus desired return.
The Lessee in a finance lease arrangement is normally
responsible for maintenance of the leased asset. Usually,
after the expiration of the primary lease period,
the Lessee has a choice of either purchasing the asset
through an arms length deal or extending the lease
over a secondary period.
Features of Finance
Lease
1.
Fixed obligation – The Lessee and Lessor are
obligated to the lease and cannot cancel it before
the expiration of its tenor.
2.
Long Tenor – Finance lease usually last for
a longer period of time, usually over two years, to
cover the service life of the leased asset during
which time the Lessee must fulfil the obligations
of the lease.
3.
Fully Amortising – Finance lease contracts are
drawn up in such a way as to cover the economic life
of the asset.
4.
Lease Rental payments – The total lease rentals
in a finance lease are usually higher than the original
value of the leased assets.
Operating
Lease
An
operating Lease is a contract under which the asset
is not wholly amortised during the primary period
(if any) of the lease, and where the Lessor does not
necessarily rely on the rentals in that period for
his return but looks for recovery of the balance of
his costs and of his profits from the secondary lease,
sale or re-sale of the returned asset at the end of
the lease period. In effect, the lease is for less
than the economic life of the asset and at the expiration
of the initial period, the asset can be leased to
the same or to another Lessee at a new rental.
Features
of an Operating Lease
1.
Equipment service included in cost – In an operating
lease, the lessor bears the responsibility for servicing
and maintaining the asset and these expenses are built
into the cost of the lease.
2.
Equipment not fully amortised – Because the
lease tenor is often less than the service life of
the equipment, the lease is not fully amortised.
3.
Lease is cancellable – The Lessee can cancel
the lease before the expiration of the primary lease
period for which the Lessor may charge a penalty fee.
4.
Availability of extra services – Apart from
the provision of the asset and servicing it, the Lessor
may provide extra services to the Lessee with an alternative.
It
is important to distinguish between a finance lease
and an operating lease as the type of lease determines
who gets the capital allowance from the federal Board
of Inland Revenue (FBIR) – the Lessor or the
Lessee.
The
tax laws require that the assets leased must be wholly,
exclusively, necessarily and reasonably by the Lessee
for the purpose of his trade or business before any
capital allowance can be claimed. As a general rule,
the lessee and not the Lessor is entitled to claim
capital allowance on the cost of the assets in the
case of a finance lease. Operating lease, on the other
hand, is a lease where the Lessor bears all incidental
costs of maintenance and insurance apart from clearly
retaining ownership of the asset. Where all these
are clearly expressed, the Lessor is entitled to the
capital allowances on the asset. Before granting a
claim for capital allowances therefore, the Inland
Revenue would critically examine the lease contract
to determine whether:
1. Ownership would be transferred by the end of the
lease term
2. The lease contains any bargain purchase option
3. The lease term is for the major part of the asset’s
useful life
The
tax authorities adopted the classification of leased
as provided in the Statement of Accounting Standard
on leases (SAS 11) under the standard a lease qualifies
as a finance lease if the following conditions are
met:
-
The lease term covers substantially (80% or more)
the estimated useful life of the asset. Or
-The
net present value of the lease at its inception using
the minimum lease payments and the implicit interest
rate is equal to or greater than the fair value of
the leased asset, or
-The
lease has a purchase option which is likely to be
exercised.
WHY LEASING?
Leasing
may not necessarily be cheaper than other forms of
financing capital assets, yet it is embraced by all
and sundry. Below are nine reasons why this is so.
1.
Alternative source of capital
Leasing
will provide an alternative source of financing where
a company is faced with tight credit terms, bank lending
restrictions or other economic factors. It is a prudent
means of equipment acquisition. It releases credit
lines that can be used for other purposes, i.e. it
allows for full use of borrowing capacity.
2.
Affordable means of acquiring
equipment
Leasing
provides an affordable avenue for lessees to acquire
the much needed equipment with minimal initial cash
flow. This is because payment constitutes very small
fraction of the equipment cost, which is spread over
the lease period.
3.
Flexibility in lease rental payment
Lease
rental can be structured to coincide with earnings
generated from the use of the equipment. This is particularly
advantageous in a situation where companies have seasonal
cash flow.
4.
Longer Payment terms than other
forms of credit
Leasing
affords the lessee the opportunity of payment over
a longer period than with most other forms of financing.
This allows the lessee the opportunity of reducing
financial commitments particularly in times of distress.
5.
Easy Accessibility of equipment
Lease
facilities are often easier to obtain than loans.
An equipment under lease, while providing facility
for use, also serves as collateral for the lease since
ownership actually resides with the lessor. Hence,
in the event of a failure on the part of the lessee
to pay rental, the equipment can be retrieved by the
lessor.
6. Budget Limitations
Acquisition
of equipment not complemented by capital expenditure
budget can sometimes be accomplished through lease
with rental payments classified as operating expenses.
7.
Technology Considerations
When
firms purchase equipment, they face the possibility
that at sometime the asset may not be efficient as
recently manufactured one. The lessor may elect to
obtain the new version for the lessee, if he latter
desires.
8.
Collateral
There
is usually no need for additional security or collateral
for a lease. Generally, the equipment serves as security.
9.
Risk of Leakage
There
is reduced risk of leakage in equipment leasing transaction,
since the lessee does not receive cash. The lessor
purchase and supplies the equipment thus reducing
the diversion of funds.
Typical items suitable for leasing include:
1.
Office Equipment
•
Air conditioners
• Computers and related items
• Photocopiers
• Furniture and fittings etc
2.
Household equipment
•
Cookers
• Deep freezers
• Refrigerators
• Room air conditioners
• Satellite dishes
• Television sets
• Generators etc
3. Industrial and Manufacturing
equipment
•
Contractor plants and machinery, including construction
equipment
• Machine tools
• Oil exploration
• Printing presses
• Quarrying and mining equipment
• Textile machinery
• Water drilling etc
• Telecommunications
4. Transportation equipment
•
Aircraft
• Business cars
• Commercial vehicles
• Locomotives
• Ships, fishing trawlers and oil tankers
5.
Miscellaneous equipment
•
Agricultural equipment
• Hotel equipment
• Medical and dental equipment
• Shop fittings
• Vending machines
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