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Leasing is understood to be a financial instrument that permits an individual or the lessee to enjoy the utility of a physical asset without possessing it or without assuming ownership of the asset. Leasing can also be defined as an arrangement between two main parties namely: the lessor or the leasing company and the person or the lessee.
The customer or the lessee can rent the asset from the company for a particular period of time. The rent for leasing are always predetermined and are due after a particular fixed intervals of time and the lessee assumes the ownership of the property for the entire lease period.
There is no purchase option at the expiry of the lease period. Leasing applies to equipments that are expensive and bulky or large. Leasing has advantage of tax exemption since the individual avoids the per annum leasing charges; also there is the advantage of avoiding the making of down payments.
A company with huge capital outlay will use their profits to lease assets by simultaneously defraying charges from depreciation as profits. Business organizations consider the use of leasing as the best instrument to apply for capital equipment during the financial period of the investment.
There is always an operational capital that is accrued from leasing especially when the companies supply the equipment instead of financing the equipment, this kind of capital accrued is called financial leasing (Mishra, 2008). Leasing can be an instrumental source of finance and can be used to modernize business operations.
Types of lease
There are five types of leasing namely: financial leasing, operating lease, leverage lease, the sale and lease back and cross border lease.
Financial lease: This is a type of lease which cannot be revoked or canceled. The lessee enjoys the use of the asset for a long period of time; the lessee maintains, insures and can avail it for after sale services and warranty.
In this type, the lessee bears responsibility over obsolescence for the entire period of lease. Financial lease has the option of purchase after the predetermined period. Nominal charges are charged to the lessee so as to finance legal and other costs.
Operating lease: the contract period between the parties’ covers a period of less than economic life of the equipment; the contract is short tem in nature. The contract can be terminated via a notice as stipulated in the agreement terms. Obsolescence risks, maintenance costs and other expenses lie in the hands of the company or lessor.
Leverage lease: this only applies to assets of massive capital and involves three parties; the lesser, lessor and the lender or other stakeholders.
Sale and lease back: this is an arrangement where a company can sell an asset to a company the can lease it out. The lessee can get the equipment at a market value. The lease back arrangements are at a net basis.
Cross border leasing: this is also called transactional leasing and it is a leasing transaction between parties based on different countries (Burt, Petcavage, & Pinkerton, 2010).
Advantages of Leasing
- Leasing allows for alternative use of funds
- It is a source of Immediate and less expensive credit
- It is flexible
- Leasing enhances additional borrowing
- Leasing protects goods against being obsolete
- Leasing is a source of 100% financing
Disadvantages of Leasing
- High cost of financing when compared with debt financing
- Risk of payment default may result in loss suffered by the lessor (Mishra, 2008).
Burt, D. N., Petcavage, S. D., & Pinkerton, R. L. (2010). Supply management (8th ed.). Boston, MA: McGraw‐Hill.
Mishra, S. (2008). Leasing. Scribd. Web.