Leasing

A leasing contract is an agreement in which the lessor (owner of the equipment) conveys to the lessee
(user), the right to use the equipment in return for a payment over a particular period of time.
Lease: A rental agreement for the use of an asset that extends for a year or more and involves a series
of fixed payments.
The owner is the Lessor, while the user is the Lessee.
When the lease contract expires, asset reverts to the lessor. However, the lease agreement often gives
the lessee the option (usually, for capital leases) to purchase the asset or renew the lease.
Why Lease?
Convenient
Cancellable options are valuable
Maintenance is provided
Standardization leads to low administrative and transaction costs
Tax shields
Preserves capital
Types:
Operating Lease: Short-term or cancellable during the contract period at the option of the lessee;
generally, for the use of the asset for short-term purposes. Lessee recognizes the lease payments as
expenses in his income statement.
Capital/ Financial Lease: Extending over the economic life of the asset and cannot be cancelled or
can be cancelled only through reimbursement of losses to lessor; generally, a source of financing.
Lessee recognizes the lease payment/s as capital expenditures and shows it as asset in the balance
sheet.
By Services:
Full-service/ Rental Lease: Lessor maintains, insures and pays asset taxes (if any) on the asset.
Net Lease: Lessee agrees to maintain, insure and pay asset taxes (if any) on the asset.
By Arrangements:
Direct Lease: Lessee identifies asset, arranges for lessor to buy from manufacturer, and signs lease
contract with lessor.
Sale-and-Leaseback: Lessee sells asset already owned and leases it back for the long-term; therefore,
continues to be able to use the asset but no longer owns it.
Differences between Operating and Financial leases:

Title: In a finance lease agreement, ownership of the property may be transferred to the
lessee at the end of the lease term. But, in operating lease agreement, the ownership of the
property is retained during and after the lease term by the lessor.

Balloon/residual amount: In finance lease agreement, there is a balloon/residual option for

the lessee to purchase the property or equipment at a specific price. But, under an operating
lease, the lessee does not have this option. The balloon/residual on a finance lease is set using
ATO asset guidelines.

Running costs & administration: Under an operating lease all running costs (servicing,
registration, tyres, insurance etc) are included in the lease within the designated term and
usage km with one set monthly repayment amount. Under a finance lease these are generally
not included meaning there can be greater administration and price fluctuation for the lessee.

Account treatment: Operating lease is treated as expenses (ie off balance sheet items) where
as finance lease is included as an asset for the lessee.

Leasing:
Operating and Finance Leases

The two basic forms are finance and operating leases. The major differences between them are
set out in IAS 17.
A finance lease is a form of financing that transfers substantially all the risks and rewards
incidental to ownership over a leased asset from the lessor to the lessee. By signing the contract
and delivering the leased asset, the lessor transfers economic ownership over the leased asset,
while legal ownership is transferred only upon the expiration of lease, on payment of the final
instalment. In a finance lease, the lessee uses the leased asset for most of its lifecycle, as with
loans.
An operating lease is a lease whereby all the risks and rewards incidental to ownership over the
leased asset remain with the lessor. In this case, the lessor retains the economic and legal
ownership over the leased asset, while the lessee has only right of use. Upon the expiration of
contract, the leased asset is returned to the lessor. Under an operating lease, the lessee uses the
leased asset for less than its useful life.
The difference between the finance and operating leases is visible in their tax treatment. The
finance lease provider issues an invoice to the lessee immediately upon contract activation. The
invoice contains the full obligation: principal + rent per contract (compound interest for the
entire duration of the contract period) + all VAT (VAT on the leased asset, invoicing VAT, and
VAT on the interest). Based on this, the lessee will include the piece of equipment in their
Balance Sheet. Accordingly, the equipment will be recorded in assets, while the long-term
commitment to lease will be recorded in liabilities. This piece of equipment is subject to
depreciation. If it is a fixed asset for which the user is entitled to tax deduction, the invoice will
be the basis for the deduction of the full amount of VAT.
With an operating lease, the lessee receives a monthly invoice for their lease obligation. The
invoice shows the net value + VAT. The net value includes repayment of principal + interest for
the associated period. In this type of lease, there is no change in the lessee's balance sheet.
Monthly invoices for the lease are recorded as an expense and are reflected in the income
statement. The leased asset is present in the lessor's books. If it is an item for which the user is
entitled to VAT deduction, the deduction will be made based on monthly invoices, where VAT is
calculated for each monthly instalment. The following table gives an overview of the basic
differences between the finance and the operating lease:
Table 1. Basic differences between the finance and the operating lease
No. Characteristics

Finance Lease

Operating Lease

1.

Tax treatment

As trade of goods

As trade of services

2.

Financial aspect

Long-term loans

Long-term lease

3.

Legal ownership

Lessor

Lessee

4.

Economic ownership

Lessee

Lessor

5.

Tax savings for the user Depreciation and interest

Rent

6.

Risks of using good

Lessee

Lessor

7.

Lease period

Optional

Up to 75% of the asset's

economic life

8.

VAT invoicing

At the inception of lease

On the individual rental,
transaction, on the total value
each rental being taxed,
of the financed asset + VAT on
net rental + VAT
interest

9.

Upon expiry of the

Transfer of ownershipUpon payment of the final
contract, the lessee has a
after expiry of the leaseinstalment, the lessee becomes
right to purchase the asset
contract
owner
at market value

Where the user does not

Where the user wants towant to own the leased
10. Suitable form of leasing
become the owner of the asset asset, the lessor bears the
entire risk
Source: IAS