Chapter 22

Leasing and Hire-

Purchase
 Chapter Objectives
To understand:

1. Lease financing
2. Leasing in India
3. Rights, obligations and responsibilities of the lessor
4. Rights, obligations and responsibilities of the lessee
5. Types of leases
6. Advantages and disadvantages of leasing
7. Hire purchase
8. Difference between leasing and hire purchase
9. Instalment-purchase system
10. Difference between hire purchase and instalment
Lease Financing

Lease is a contract between owner of an

asset (lessor) and the user of the asset
(lessee) under which the lessor gives the
right to the lessee to use the asset for
agreed period of time and consideration,
called lease rental.
Concept of Leasing
• Lease finance denotes procurement of assets through lease. The subject of
leasing falls in the category of finance.
• Leasing has grown as a big industry in the USA and UK and spread to other
countries during the present century.
• In India, the concept was pioneered in 1973 when first leasing company was set
up in Madras and the eighties have seen a rapid growth of business.
• Lease as a concept involves a contract whereby ownership, financing and risk
taking of any equipment or asset are separated and shared by two or more
parties.
• Thus, the lesser may finance and lessee may accept risk through the use of it
while a third party may own it.
• Alternatively, the lesser may finance and own it while the lessee enjoys the use
of it and bears the risk
Leasing and Economic Growth
 Leasing helps start-ups, small businesses and
growing businesses to further capital
investment.
 The cost of buying new equipment to meet the
changing and growing business needs can be
difficult for most small businesses.
 Leasing is infrastructure-friendly and can
contribute to a country’s infrastructure growth.
 infrastructure. Leasing industry has met the
needs of the Indian government to finance the
railways or telecommunications, or computers
for e-governance in various states.
Leasing in India
 The first leasing company of India pioneered the concept of
leasing in India in 1973.
 The banks were allowed to enter into this business in 1994.
The State Bank of India is into big-ticket finance leasing. The
cost of the equipment being leased is the ticket size. The
ticket size may be small, medium or big. The bank
undertakes leasing contracts worth a minimum of Rs. 5 crore.
 There were around 400 companies in the leasing business in
the 1990s.
Features of Leasing
• 2 Parties
• Selection of an asset
• Purchase of an asset
• Use of the asset
• Rentals and installments payment
• Recovering the cost of an asset.
• Option of acquiring ownership of the asset.
• A lease is a contractual agreement in which:
A party owing an asset i.e. lesser
Provides an asset for use to another party i.e. lessee
For an agreed period of time i.e. lease period
For a consideration i.e. lease rentals.
Rights, Obligations and Responsibilities of the
Lessor
 Obligation of acquiring the lease asset according to the
lessee’s specification.
 Right of ownership of the leased asset.
 Right to claim depreciation on the asset.
 Right to ensure that the asset is put to fair use and
within the limitations contained in the agreement.
 Right to recover the rentals and other sums payable by
the lessee under the agreement.
 Right to sue in case of conversion of the asset by the
lessee.
 Right to terminate the lease contract in case of misuse of
leased goods by the lessee or if the lessee does not pay
the lease rentals.
 Rights, Obligations and
Responsibilities of the Lessor

 Right to reimbursement of damages in case of misuse of

leased assets.
 Right to the recovery of the leased asset in the event of
the lessee’s failure to pay the lease rentals or
 lessee’s bankruptcy.
 Responsibility towards the lessee for legal deficiencies of
the leased asset (if the third person exercises a right over
the lease asset, which excludes, diminishes or limits
lessee’s unrestricted possession of the asset) and
responsibility towards the lessee for suffered damages in
this respect.
Rights, Obligations and Responsibilities of the
Lessee
 Obligation to pay the lease rentals periodically as
specified in the lease agreement.
 Obligation to keep the asset insured at all times for an
amount equal to the full insurable value of the asset.
 Obligation to return the leased asset to the lessor upon
expiration or earlier termination of this lease agreement.
 Right to use and operate the asset during the lease
period, according to the terms of the lease agreement.
 Right to terminate the financial lease contract if the
asset has not been delivered in line with the contract (if
the supplier does not deliver the asset, delivers the
asset with delay or if the asset has a material
deficiency).
Rights, Obligations and Responsibilities of the
Lessee
 Right of damage compensation and
termination of the lease rental payment
until the delivery of the leased asset is
in line with the lease contract.
 Responsibility for the damage caused by
using the lease asset.
 Responsibility for a sudden devastation
or damage of the leased asset from the
moment of taking over the asset.
 Types of Leases
 Financial Lease
 Operating Lease
 Sale and Leaseback
 Leverage Leasing
 Close and Open-ended Lease
 Upfront and Back-end Lease
 Percentage Lease
 3N Lease
 Cross-border Lease
Financial Lease

• Finance lease, also known as Full Payout Lease, is a type

of lease wherein the lessor transfers substantially all the
risks and rewards related to the asset to the lessee.
Generally, the ownership is transferred to the lessee at
the end of the economic life of the asset. The lease term
is spread over the major part of the asset life. Here, a
lessor is only a financier. An example of a finance lease is
big industrial equipment.
Operating Lease
• In an operating lease, risk and rewards are not transferred
completely to the lessee. The term of a lease is very small
compared to the finance lease. The lessor depends on many
different lessees for recovering his cost. Ownership along
with its risks and rewards lies with the lessor. Here, a lessor
is not only acting as a financier but he also provides
additional services required in the course of using the asset
or equipment. An example of an operating lease is music
system leased on rent with the respective technicians.
Sale & Lease Back
• In the arrangement of sale and leaseback, the lessee
sells his asset or equipment to the lessor (financier)
with an advanced agreement of leasing back to the
lessee for a fixed lease rental per period. It is
exercised by the entrepreneur when he wants to free
his money, invested in the equipment or asset.
Direct Lease
• A direct lease is a simple lease where the asset is either
owned by the lessor or he acquires it. In the former case, the
lessor and equipment suppliers are one and the same person
and this case is called ‘bipartite lease’. In a bipartite lease,
there are two parties. Whereas, in the latter case, there are
three different parties viz. equipment supplier, lessor, and
lessee. And it is called a tripartite lease. Here, equipment
supplier and lessor are two different parties.
Single Investor Lease
• Single investor lease, there are two parties – lessor
and lessee. The lessor arranges the money to finance
the asset or equipment by way of equity or debt. The
lender is entitled to recover money from the lessor
only and not from the lessee in case of default by a
lessor. Lessee is entitled to pay the lease rentals only
to the lessor.
Leveraged Lease
• Leveraged lease, on the other hand, has three parties
– lessor, lessee, and the financier or lender. Equity is
arranged by the lessor and debt is financed by the
lender or financier. Here, there is a direct connection
of the lender with the lessee and in a case of default
by the lessor. The lender is also entitled to receive
money from the lessee. Such transactions are
generally routed through a trustee.
Domestic & International Lease
• When all the parties to the lease agreement reside in the same
country, it is called domestic lease.
• The International lease is of two types – Import Lease and
CrossBorder Lease. When lessor and lessee reside in the same
country and equipment supplier stays in a different country, the lease
arrangement is called import lease. When the lessor and lessee are
residing in two different countries and no matter where the
equipment supplier stays, the lease is called cross-border lease.
Subleaes
• A sublease is a rental agreement where the original lessee(tenant)
rents out the premises to another person called the sub-tenant or
sublessee. The new tenant gets few rights as the sub-lessee. The
original tenant (lessee) can only give those rights to the new tenant
(sub-lessee) which he has got from the original landlord (lessor). He
cannot pass on more rights of use on the property. The flow of rent is
from the sublessee to the lessee and the lessor/owner. The risk of
rent is always mainly borne by the lessee. In case the sub-lessee is
unable to make full or timely payment to the original lessee, the
lessor is still entitled to his timely rents and the risk is borne by the
lessee.
Advantages of Leasing
• To Lessor:
• Assured Regular Income: Lessor gets lease rental by leasing an asset during
the period of lease which is an assured and regular income.
• Preservation of Ownership: In case of finance lease, the lessor transfers all
the risk and rewards incidental to ownership to the lessee without the
transfer of ownership of asset hence the ownership lies with the lessor.
• Benefit of Tax: As ownership lies with the lessor, tax benefit is enjoyed by
the lessor by way of depreciation in respect of leased asset.
• High Profitability: The business of leasing is highly profitable since the rate
of return based on lease rental, is much higher than the interest payable
on financing the asset.
Advantages of Leasing
To Lessee:
•Use of Capital Goods: A business will not have to spend a lot of money for
acquiring an asset but it can use an asset by paying small monthly or yearly
rentals. Tax Benefits: A company is able to enjoy the tax advantage on lease
payments as lease payments can be deducted as a business expense.
•Cheaper: Leasing is a source of financing which is cheaper than almost all
other sources of financing.
•Technical Assistance: Lessee gets some sort of technical support from the
lessor in respect of leased asset.
•Inflation Friendly: Leasing is inflation friendly, the lessee has to pay fixed
amount of rentals each year even if the cost of the asset goes up.
•Ownership: After the expiry of primary period, lessor offers the lessee to
purchase the assets— by paying a very small sum of money.
Disadvantages of Lease Financing
To Lessor:
•Unprofitable in Case of Inflation: Lessor gets fixed amount of lease
rental every year and they cannot increase this even if the cost of asset
goes up.
•Double Taxation: Sales tax may be charged twice: First at the time of
purchase of asset and second at the time of leasing the asset.
•Greater Chance of Damage of Asset: As ownership is not transferred,
the lessee uses the asset carelessly and there is a great chance that
asset cannot be useable after the expiry of primary period of lease.
Disadvantages of Lease Financing
To Lessee:
•Compulsion: Finance lease is non-cancellable and even if a company does
not want to use the asset, lessee is required to pay the lease rentals.
•Ownership: The lessee will not become the owner of the asset at the end of
lease agreement unless he decides to purchase it.
•Costly: Lease financing is more costly than other sources of financing
because lessee has to pay lease rental as well as expenses incidental to the
ownership of the asset.
•Understatement of Asset: As lessee is not the owner of the asset, such an
asset cannot be shown in the balance sheet which leads to understatement
of lessee’s asset.
Hire Purchase

A hire-purchase agreement is a contract whereby

the owner of the goods lets them on hire to
another person called the ‘hirer or hire purchaser’
on payment of rent, to be paid in instalments,
and upon an agreement that when a certain
number of such instalments is paid, the title in
the goods will pass to the hirer.
Essentials of Hire Purchase

• The delivery of goods will be given by the owner of the

goods to the hire purchaser.

• Payment is to be made in instalments.

• Ownership of the goods passes to the hire purchaser only on

payment of the last instalment.

• In the event of any default by the buyer, the seller can take
back the possession of the goods, and the

• money paid by the buyer will be adjusted as rent for using

the assets.
Difference Between Lease and Hire Purchase
 Installment Purchase

• Instalment-purchase system is a credit sale in which the seller

gives the facility to the buyer to pay the money in agreed
installments.
• Essential characteristics of this system are as follows:
• The buyer gets the immediate possession and ownership of the
goods.
• The payment of price has to be made in agreed instalments.
• In the event of default by the buyer, the seller can sue the
buyer for recovery of the balance payment.
Characteristics of a Forfaiting Transaction