Course code: F-201 Course title: Financial accounting -2

Submitted to: Tahmina Akter Lecturer Department of Finance University of Dhaka

Submitted by:
Name Roll Section B B B B B

Md. Mostafa Kamal Md.Sakib Bin Abdul Hannan Md. Mehdi Hasan Parvaj Mosaraf Belal Hossain

16-058 16-096 16-112 16-140 15-132

BBA 16th Batch Department of Finance University of Dhaka

Date of Submission: 26-05-2011

Letter of Transmittal
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Date: 26th May, 2011. To Tahmina Akter Lecturer Department of Finance University of Dhaka

Subject: Submission of report A Report on Lease Financing. Dear Madam, We are pleased to submit the report you have assigned to us. The report paper was to prepare the term paper on the course named Financial Accounting-2 Course # F 201, as a part of our academic activities. This is the report on A Report on Lease Financing. The report reviews that how leasing company leases equipment. And we have focused a specific lease agreement of United Leasing Company with Delta Pharma Limited to have the real experience. We tried our best to prepare this report a fault free, but it is not possible. We hope that you will take any mistake with kind consideration.

Thank you. Sincerely Mostafa Kamal (On behalf of the group-)

A Report on Lease Financing

Contents

TO P IC
1. Acknowledgement 2. Executive Summary Background of the report Objective of the report Methodology and sources of information 3. Introduction 4. Lease Financing 5. Advantage and disadvantage of leasing 6. Sources of lease financing 7. A lease contract 8. Findings 9. Conclusion 10. Bibliography

P AG ES
05 06 07 07 07 08 09 11 13 18 21 22 22

Acknowledgement

This report entitled A Report on Lease Financing is submitted as the requirement of a part of the study of Financial Accounting-2 in the BBA program conducted by Department of Finance, University of Dhaka. To prepare this report an intensive study was made covering various terminologies with the help of books named Intermediate Accounting by Donald E. Kieso and Weygandt.

At first we want to pay our gratitude to all mighty Allah for preparing the report successfully. We are extremely grateful to our honorable course teacher Tahmina Akter, lecturer, Department of Finance, University of Dhaka for her painstaking guidance, suggestion and all type of support & supervision to prepare this report. She continuously reminded us for the preparation of this report paper and finally gave a out-line to write down the paper spending her valuable time. Without her untiring efforts, completion of this report paper would have been impossible.

We like to give thanks especially to our friends and many individuals, for their enthusiastic encouragements and helps during the preparation of this report us by sharing ideas regarding this subject and for their assistance in typing and proof reading this manuscript.

Executive Summary

Lease financing is the most important issue that determines the direction of financial behavior in an organization, a financial level of effort, and the organizations level of persistence in the face of obstacles of other types of financing. Now-a-days lease financing is the most emphasized topic to any challenging institution or organization to develop their financial resources as well as profit maximization or maximization of owners equity.

Lease financing is so central to management because it explains why it is better for the organization to gather financially solvency by lease financing. By lease financing an organization can reach its specific destination. If an organization has effective lease financing efficiency it can survive & develop quickly than others. At first an organization considers lease financing and other financing cooperatively with one another then it takes decision to apply lease financing or other financing whichever is best. If other financing is the best than the lease financing then it will be selected, not lease financing. So from this comment it will be clear that lease financing must be selected it is not necessary. So which is the best is considerable matter.

Background of the Report

As a Part of Financial Accounting-2 course, we have prepared this report. Our course teacher, Tahmina Akter, instructed us to prepare a report on Lease Financing. We have made a detailed and critical analysis on the topic-All the five members of our group provided their sincerity and serious effort to prepare this term paper and the term paper submitted today 26th May, 2011.

Objective of the Report The main objective of our term paper is to show the lease agreement of a leasing company. We have study about advantage of leasing, various features of leasing but while preparing this report we have understood how leasing is important for company.

Methodology and sources of information

The term paper is written by using secondary resources. To prepare this term paper I have taken the help of numerous books, computer lab of business faculty of university of Dhaka. In this term paper I sorted information shortly and to collect information we went to computer lab and central library of Dhaka University. Besides I have also collected information through numerous sources such as The Daily Star and other daily news papers, journals etc.

INTRODUCTION

A lease is a contract whereby the owner of an asset (the lessor) grants to another party (the lessee) the exclusive right to use the asset in return for the payment of rent. Lease financing in Bangladesh means financing according to the methods of lease in Bangladesh. Sometimes it is more acceptable than others financing. Actually it is more profitable in some special sectors where other financing will be less profitable than lease financing. Most of us are familiar with lease of apartments, cars, and telephones. Bangladesh is a developing country, so lease financing is not very easy to apply here. In spite of these problems there are many sectors where lease financing is strictly applied. The key difference between a finance lease and an operating lease is whether the lessor (the legal owner who rents out the assets) or lessee (who uses the asset) takes on the risks of ownership of the leased assets. The classification of a lease (as an operating or finance lease) also affects how it is reported in the accounts. The classification of large transactions, such as sale and leasebacks of property, may have a significant effect on the accounts and on measures of financial stability such as gearing. However, it is worth remembering that an improvement in financial gearing may be offset by a worsening of operational gearing and vice-versa.

Lease Financing
Leasing:
A lease is a contractual agreement between two parties establishing an arrangement for the use of an asset in return for periodic payments by the user. In a lease arrangement: The lessor is the asset owner, who receives the periodic payments. The lease makes the payments to the lessor in return for using the asset.

Types of leases:
All leases can be categorized broadly as either operating or financial leases. In turn, financial leases can be categorized into specific types. We will discuss the various types of leases below. Operating leases: An operating lease is a short-term, cancelable lease. A simple example of an operating or service lease is a lease for telephone service. Financial leases: A financial lease is typically a long term, no cancelable lease- the opposite of an operating lease. At the termination of the lease contract, the lessee often can either renew the lease or purchase the asset. Features of operating leases: 1. The lease is cancelable by the leasee prior to its expiration. 2. The lessor provides service, maintenance, and insurance.

3. The sum of all the lease payments by the lesee does not necessarily fully provide for the recovery of the assets cost.

Features of financial leases: 1. The lease is not cancelable by the lessee prior to its expiration date. 2. The lessee is typically responsible for service, maintenance, and insurance for the asset. 3. The asset is fully amortized over the life of the lease.

Financial leases can be divided into two basic forms:

1. Direct lease: In the straightforward arrangement, the firm leases an asset it did not previously own. The firm simultaneously signs the lease agreement with the lessor and orders the equipment from the manufacturer. The lessor pays for the equipment, which is sent to the firm. The firm makes lease payments to the lessor based on a lease agreement worked out by the two parties. If the direct lease is from the manufacturer, then the manufacturer and the lessor are one and the same.

2. Sale and leaseback: In this arrangement the firm sells an asset it currently owns and then leases the same asset from the buyer. Lease payments are set to return the full purchase price plus a rate of return deemed reasonable. The advantage to the lessee is that it allows the firm to continue using the asset while providing cash that can be used elsewhere.

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Advantages and Disadvantages of Lease Financing for Businesses

It has become increasingly more common in recent years for companies to lease equipment. Each leasing agreement needs to be read through carefully to understand the terms and conditions within said lease. Typically a lease can run anywhere from one to five years. Most equipment necessary in commercial businesses today, including technical equipment, can be leased. Some leases provide an option to then purchase the equipment at substantially less money when at the end of the term of the lease. By leasing equipment, if structured properly, you can maintain your credit availability, as the lease debt does not have to be considered a direct liability on your financial statements. This is advantageous, as it does not limit your ability to borrow from lending sources.

Advantages of lease financing:

It offers fixed rate financing; you pay at the same rate monthly. Leasing is inflation friendly. As the costs go up over five years, you still pay the same rate as when you began the lease, therefore making your dollar stretch farther. (In addition, the lease is not connected to the success of the business. Therefore, no matter how well the business does, the lease rate never changes.) There is less upfront cash outlay; you do not need to make large cash payments for the purchase of needed equipment. Leasing better utilizes equipment; you lease and pay for equipment only for the time you need it.
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There is typically an option to buy equipment at end of lease term. You can keep upgrading; as new equipment becomes available you can upgrade to the latest models each time your lease ends. Typically, it is easier to obtain lease financing than loans from commercial lenders. It offers potential tax benefits depending on how the lease is structured.

One of the reasons for the popularity of leasing is the steady stream of new and improved technology. By the end of a calendar year, much of your technology will be deemed "dinosaurs." The cost of continually buying new equipment to meet changing and growing business needs can be difficult for most small businesses. For this reason leasing is very advantageous. Leasing can also help you enhance your status to the lending community by improving your debt-to-equity and earnings-to-fixed assets ratios. There are a variety of ways in which a lease can be structured. This provides greater flexibility so that the lease is structured to best accommodate the individual cash flow requirements of a specific business. For example, you may have balloon payments, step up or step down payments, deferred payments or even seasonal payments.

The actual advantages of leasing:

The most important reason for leasing remains the tax reason. This advantage exists because firms are in different tax brackets, allowing a firm that can not take full advantage of a potential tax shield to shift such a shield to another firm. If the lease payments are set at proper rate, the firm that does the transferring can benefit, as can the lessor. Although someone has to lose, that someone will be the IRS.

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Disadvantages of lease financing:

Leasing is a preferred means of financing for certain businesses. However it is not for everyone. The type of industry and type of equipment required also need to be considered. Tax implications also need to be compared between leasing and purchasing equipment.

You have an obligation to continue making payments. Typically, leases may not be terminated before the original term is completed. Therefore, the renter is responsible for paying off the lease. This can pose a major financial problem for the owners of a business experiences a downturn. You have no equity until you decide to purchase the equipment at the end of the lease term, at which point the equipment has depreciated significantly. Although you are not the owner, you are still responsible for maintaining the equipment as specified by the terms of the lease. Failure to do so can prove costly.

Leveraged lease:

A lease involving a third party that lends the lessor part of the funds necessary to purchase the asset to be leased.

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Sources of lease financing:

1. Equipment manufacturers:

Durable-goods manufacturers often establish subsidiary leasing or credit companies. One of the main reasons that manufacturing companies provides lease financing is to encourage the use of their product.

2. Financial institutions:

Banks, bank holding companies, and life insurance companies. These institutions are heavily involved in long-term financial leases. From their standpoint, leases are merely a secured lending. 3. Independent leasing companies:

This provides much of the direct leasing.

The effects of leasing on the firm:

The financing effect:
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It is a form of borrowing. The contractual agreement on the lease payments is no cancelable. Therefore as other types of debt, failure to make the lease payments can result in bankruptcy. Both lessors and lessees generally, and correctly, view a financial lease as a form of borrowing. Leasing is similar to debt; it has an impact on the amount of borrowing a firm can do. Generally, the more a firm leases, the less it can borrow. This debt displacement is an implicit cost of leasing.

The tax effect:

For tax purposes, the lease is entitled to a full deduction of all qualified lease payments. Therefore, like other forms of borrowing, the government subsidizes the cost of leasing.

The reporting effects:

Leasing used to be referred to as off-balance sheet financing. Under prior accounting practices, because the firm did not own the asset, neither the asset nor the companion lease liability had to appear in the body of the balance sheet. A footnote reference, often a very terse one, was sufficient. The superficial effect was to understate the firms indebtedness position.

Lessee reporting:
The capitalized value of capital leases and their companion liabilities are put in the body of the lessees balance sheet. These capitalized values are the present value of the lease payments. Thus the present value of the lease payments appears on the right-hand side of the balance sheet as a liability and on the left-hand side as an asset.

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(Lessor)

ULC was established in 1989 as a public limited company, to cater the investment needs of our economy.

ULC provides lease financing facilities to all market segments of customers, Small & Medium Enterprises, Commercial Houses, Large Corporate organizations.

Under Lease financing They provide; Industrial machinery and motor vehicles at concessionary term. Machinery and Furniture for Hospital use. Truck or Bus for Transportation. Equipment or Furniture for Official use.

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(Lessee)

Delta Pharma Limited (DELTA PHARMA) has been propelling steadily towards its goal (Better Care... Better Cure...) since its launch on November 21, 2004. It is a public limited company.

Vission The vision is to reach a level of excellence in pharmaceuticals through a sustained effort to quality assurance and to achieve a global standard through the indoctrination of a culture of excellence. Mission Our mission is to benefit people and improve their quality of life through our quality products. As a generic company, our growth is closely knitted to the satisfaction of our customers. We would like to ensure customer satisfaction through providing quality medicine at affordable cost, launching new molecules & expediting export to all possible avenues. We are committed to achieving our goal through skilled, creative, and motivated employees.

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A Lease contract of United Leasing company with Delta Pharma Limited

ULC agrees to lease a drug manufacturing machine to Delta pharma company on January 1, 2010. ULC has added following information in the contract: 1. The lease agreement is noncancellable in nature with 6 years time period. 2. There will be no renewable option after lease term. 3. The cost of the machine was tk.245000 and the fair value of the machine at January 1, 2010 is tk.245000. 4. Machine will be reverted to the leesor at the end of this term at which time the machine will have scrape value worth tk.43622 which is ungurrenteed. 5. Delta Pharma will bear the responsibility all executive cost. 6. ULC requires equal rental payment annually beginning January 1, 2010.

7. Collectability of the lease payment is reasonably predictable. There are no uncertainties surrounding the amount of costs yet to be incurred by the ULC.

Required calculation by ULC

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Rental payment calculation Fair market value of the leased asset to lesor Less: Present of the ungurenteed residual value (43622X.56447) Amount to be received through lease payment Six periodic lease payment (tk.220376.69/4.79079) tk.220376.69 tk.46000 tk.245000 tk.24623.31

United Leasing Company (Lessor) Lease Amortization Schedule

Date Annual lease payment plus URV 1-1-10 1-1-10 1-1-11 1-1-12 1-1-13 1-1-14 1-1-15 1-1-15 46000 46000 46000 46000 46000 46000 43622 19900 17290 14419 11261 7787 3965 46000 26100 28710 31581 34739 38213 39657 245000 199000 172900 144190 112609 77870 39657 0 Interest on lease receivable Recovery of lease receivable Lease receivable

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Journal entries for ULC

Journal entries given by the United Leasing Company for the first two years: Date 1-1-10 Journal Lease receivable..Dr Equipment..Cr 1-1-10 12-31-10 1-1-11 Cash.Dr Lease Receivable...Cr Interest Receivable.Dr Amount(tk) 245000 245000 46000 46000 19900

Interest Revenue...Cr 19900 Cash..Dr 46000 Lease Receivable Cr 26100 19900 17290 17290 Interest Receivable.Cr Interest Receivable.Dr Interest Revenu..Cr

12-31-11

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Findings
Analyzing this report we have come to terms:
1. Lease plays an important role for business. 2. Easy for business to get lease. 3. Lease agreement may contain less restrictive provisions than other debt agreement. 4. Business finds leasing cheaper than other forms of financing. 5. Business does not report an asset or liability for the lease agreement for financial reporting purposes. 6. It is a contractual agreement. 7. It may be cancellable or no cancellable. 8. Leasing provides business an opportunity to transfer tax benefit to another party.

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Conclusion
The leasing market is becoming more competitive because of the new leasing companies are entering the market. However, There are still leasing companies are doing well. The political stability and overall economic development is an essential precondition of the smooth growth of this sector. If we can ensure these two preconditions, the leasing sector of Bangladesh would be able to perform a strong role in our industrial development. If we disuses more and more about lease financing, and if we try to spread it among our general public about its advantages, we will go clearly ahead. It is very favorable to apply lease financing in Bangladesh. From above discussion, it is clear that, in many sectors lease financing is better than other financing. If we know about lease financing properly, we can use or we can avail all the advantages of lease financing where other financing is not favorable for us.

Bibliography

1. Brigham, E.F. and M.C. Ehrhardt. 2001. Financial management: Theory and practice. 10th Edition. Singapore. South- Western. 2. Bhole, L.M. 1992. Financial Institutions and Markets: structure, growth and Innovations. 2nd Edition. New Delhi. Tata- McGraw-Hill Publishing Company. Evaluation of students performance;
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3. Horne, J.C.1999. Financial Management and Policy.

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