Lease vs Hire FM Final

8/2/2019 Lease vs Hire FM Final

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Lease purchase andHire purchasePresented by:-

Group 5- 411,412,413,516,517,518


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Lease purchase

Rental agreement extending for year and more and has

series of fixed payments.

Alternative to buying

Involves two parties-Lessee-user

Lessor-owner (IBM)

Lessors-banks, Leasing companies(GE capital aviation

services)


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Lease contract

Legal contract enforceable to both the parties.

Names of the parties of the agreement.

The starting date and duration of the agreement.

Identifies the specific object being leased.

Specifies payment patterns

Provides options-purchase or take out new lease


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Types of leases

Operating lease

Financial lease types

Rental

lease(full

service)

Net lease Direct lease

Sale and lease

back

Leveraged

lease


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Advantages of lease

Leasing balances usage and cost

Leasing provides fixed rate financing

Leasing increases purchasing power

Tax shields can be used.

Leasing provides options


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Disadvantages of lease

No Ownership

Long Term Expense

Maintenance


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FINANCIAL LEASE


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A finance lease or capital lease is a commercial arrangement

where:

the lessee (customer or borrower) will select an asset(equipment, vehicle, software);

the lessor (finance company) will purchase that asset;

the lessee will have use of that asset during the lease;

the lessee will pay a series of rentals or instalments for the use

of that asset;

the lessor will recover a large part or all of the cost of the asset

plus earn interest from the rentals paid by the lessee;

the lessee has the option to acquire ownership of the asset (e.g.

paying the last rental, or bargain option purchase price)


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Impact on accounting

working capital decreases, but the debt/equity ratio

increases, creating additional leverage.

In a statement of cash flows, part of the lease payments

are reported under operating cash flow but part under

financing cash flow. Therefore, operating cash flow

increases.


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EXAMPLE

Blueline Bus Lines is considering a lease. Your operating

manager wants to buy a new bus for Rs.46 lakhs. The

bus has an 8 year life. The Bus Saleswoman says she will

lease Blueline the bus for 8 years at Rs.7.83 lakhs per

year, but Blueline assumes all operating andmaintenance costs. Should Blueline Buy or Lease the

bus?


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Cash flow consequence of the lease

contract offered to Blueline Bus:


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Blueline Bus can borrow at 10%, thus the value of the

lease should be discounted at:

.10 x (1-.3366)= 6.634%.


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Blueline Bus Lines lease cash flows

can also be thought of as loan

equivalent cash flows.

NPV= 40.80-40.86

= -0.06 lakhs


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Value of lease for lessor

2 3

4 5 6 7

906.53 809.76 737.18NPV lease = 4080.56

1.06634 (1.06634) (1.06634)

682.75 641.92 611.3 795.02

(1.06634) (1.06634) (1.06634) (1.06634)6.24 or Rs.6.24 thousands

The lessor can only win on lessee expense


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Other Types of leases

Capital Lease

(a) ownership at the end of the lease term;

(b) the asset at a bargain price;

(c) the lease term is equal to 75% or more of the estimated economic

life of the property

(d) the present value of minimum lease rental payments is equal to 90

% or more of the fair market value of the leased asset less relatedinvestment tax credits retained by the lessor.


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The first amendment lease

Gives the lessee a purchase option at one or more defined points with

a requirement that the lessee renew or continue the lease if the

purchase option is not exercised.

Full payment lease :

A lease in which the lessor recovers, through the lease payments, all

costs incurred in the lease plus an acceptable rate of return, without

any reliance upon the leased equipments future residual value.


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Sales type lease

A lease by a lessor who is the manufacturer or dealer, in which thelease meets the definitional criteria of a capital lease or direct

financing lease.

Trac

A tax-oriented lease of motor vehicles or trailers that contains a

terminal rental adjustment clause and otherwise complies with the

requirements of the tax laws.


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Blueline pays no tax

0 1 2 3 4 5 6 7

cost of new bus 4600

lease payment -783 -783 -783 -783 -783 -783 -783 -783

cash flow from lease 3817 -783 -783 -783 -783 -783 -783 -783

7

tt=1

783Value of lease = +4600 -

(1.1)

4600 - 4594.97 = +5.03, or Rs.5.03 thousands


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Operating Lease


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Operating Lease

An operating lease is similar to rent:

it is for a stated portion of time (less than the usefullife)

no ownership occurs from the relationship

rental costs are not directly associated with the

acquisition cost of an asset


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Usually not fully amortized. This means that the payments

required under the terms of the lease are not enough to

recover the full cost of the asset for the lessor.

Usually require the lessor to maintain and insure the asset.

Term: operating lease term is significantly less than the

economic life of equipment.

Lessee enjoys a cancellation option. This option gives the

lessee the right to cancel the lease contract before the

expiration date.


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Variety of lease plans

Variety of lease plans with differing add-ons or leave-outs

by different lessors but broadly falling into two categories:

Short term rentals .

Long term cancellable leases.

Full service leases

Net, but cancellable leases


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Features of an operating lease

Operating leases may not allow the asset to be virtually exhausted bythe same lessee.

Operating leases do not put the lessee in the position of a virtual owner.

The lease is either fully cancellable or partly non-cancellable and

partly cancellable.

Operating leases are non-full-payout.

The lessor may provide any services relating to the asset, such as

maintenance, or operations. In such case, the lease is wet lease.


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Example Page 706

SriramCompanys

Cost of vehicle (Limo) 3450

Other costs (op., insurance,

maintenance etc)

552

Useful life 6 years

Net salvage value 0

Depreciation rate 15%

Marginal tax rate 33.66%

Cost of capital 7%

Annual lease rental ?

h fl


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Cash flows

All the figures are in thousands


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Annual lease rental

1. Calculate the Present value of post tax cash

flows =

NPV= CF0 + CF1/(1+r) +CF2/(1+r)^2 +CF3/(1+r)^3CF4/(1+r)^4 + CF5/(1+r)^5+CF6/(1+r)^6

NPV= Rs 46.77 Lakhs


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Now Calculating the annual lease rental:

44.77= x + x/(1+0.07) +x/(1+.07)^2 +x/(1+0.07)^3

x/(1+0.07)^4 + x/(1+0.07)^5+x/(1+0.07)^6

X= Rs 9.17


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Operating Vs. Finance Lease


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HIRE PURCHASE


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WHAT IS HIRE PURCHASE?

Hire purchase is a type of installment credit under whichthe hire purchaser, called the hirer, agrees to take the

goods on hire at a stated rental, which is inclusive of the

repayment of principal as well as interest, with an option

to purchase.


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What are the income tax implications

in the case of a hire purchase?

In the hire purchase the hirer carrying business or profession

gets benefit of depreciation. He can also claim deduction on

the interest paid on hire charges, in his income tax

assessment.


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INDIAN CONTEXT- HIRE

PURCHASE ACT 1972 1) The owner delivers possession of goods thereof to a person

on condition that such person pays the agreed amount in

periodic installments.

2) The property in the goods is to pass to such person on the

payment of the last of such installments, and 3) Such person has a right to terminate the agreement at any

time before the property so passes.


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SC ARTICLE 7

SC=(NC*R*T)/100

NC (Net cash)

R (Rate 18%or less)

T (time between the date agreement is signed and last

payment is due


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SOLUTION

SC=(NC*R*T)/100 = (50000*18*5)/100=45000

HIRE PURCHASE CHARGES = 65000 + 45000 = 1,10000

BALANCE = 1,10000-15000 =95000


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ARTICLE 9- When Hirer tenders a

contract R =(SC*M*(M+1))/(N*(N+1))

M= No Of Complete Months still remaining

N=Total Number of months in the period

R=Rebate

SC=Statutory Cash Prize


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SOLUTION

R =(SC*M*(M+1))/(N*(N+1))

R=(45000*24*25)/(60*61)

7377.05 Rs.


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In case of breach

SC is hire purchase price is


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Accounting treatment

At the inception of the transaction, the finance company

should record the hire purchase installments receivables as

current asset (i.e. stock on hire)

the unearned finance income component of these

installments as a current liability under the head unmatchedfinance charges


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After end of Accounting Period

The hire purchase price less the installments received should

be shown as receivable / stock on hire

The finance income component of these installment should

be shown as current liability / unmatched finance charge.

The direct costs associated with structuring the transactions /deal should be either expensed immediately or allocated

against the finance income over the hire period.


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Cost Of Hire Purchase - HIRER

1. Down payment

2. + Service Charges

3. +Present value ofhirepurchasepaymentsdiscountedby the

cost of debt.

4. Present value of depreciation tax shield discounted by cotof capital.

5.Presentvalueofnetsalvagevaluediscountedbycostof capital.


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The NPV of HPP consist of

PVofhirepurchaseinstallments

+Documentationandservicefee.

+PVoftaxshieldoninitialdirectcost

Loan amount

Initial cost.

PVofinteresttaxonfinanceincome(interest)

PVofincometaxonfinanceincomemetedforinterest tax

PVofincometaxondocumentationandservicefee.


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HIRE PURCHASE & CONSUMER CREDIT


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Consumer Credit

Includes all asset based financing plans offered to individuals.

(eg. Cars, scooters,VCRs, TVs, Refrigerators, washing

machines etc., personal computers.).

Main supplier of consumer credit are Multinational Banks,

commercial banks, Finance cos..etc


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Consumer Credit...

Salient Features

Parties to the transaction : Bipartite arrangement - two

parties viz borrower/consumer and dealer/financier.

Tripartite Transaction - dealer, financier, and customer.

The dealer arranges the credit from the financier.

Structure of the transaction :

Hire-Purchase , Conditional Sale , Credit Sale .

Hire Purchase - Most tripartite consumer credit

transactions are of this type. Customer option to purchase

the asset on completion of the pay back period.


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Consumer Credit ...

Conditional Sale : Ownership not transferred until full

payment of purchase price, including the credit charge. The

customer cannot terminate the agreement.

Credit Sale : Ownership transferred to the customer on first

instalment payment. But the agreement cannot be cancelled.

Payment Period and ROI :

Payment period - 12 -60 months.

ROI - generally flat rate. Effective Rates generally not

disclosed. Sometimes in place of ROI, the EMI for different

payment periods is mentioned.


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Consumer Credit ...

Security :

First charge on assets. The consumer cannot sell the hypothecated

asset.

Evaluation

Can be made with Effective Rate of Interest and rebates for earlyrepayments.


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Installment Credit Systems

A system of customer financing, whereby the payments of the

purchase price is deferred, to be paid in reasonable installments

is known as installment credit systems.

Features:

An ordinary sale of goods with easy payment system

The buyer obtains ownership and possession on payment of the

first installment

Payment is made through a number of installment

No possibilities of the article sold being returned to the seller,

since sale is complete immediately after the execution of the

agreement

Hi P h d i ll


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Hire Purchase and installment

systemSimilarities:

1. They are forms of consumer finance for the sale of expensive and

durable goods

2. They are recognized by the Indian sale of goods act

3. Recovery of the price is through installments spread over a fixed

period of time

Suitability:

1. Separate identity or individuality to facilitate their recovery when

there is a default.

2. Durability to sustain the long period of installments and facilitaterepossession in the event of a default

3. High enough value to justify a hire purchase agreement

4. Standard specifications to facilitate reselling , if necessary

Example:


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Example:

Sum of the Years Digits

Nidhi finance offers a hire purchase proposal to one of its

customers, synthetic Chemicals, which requires an equipment

costing Rs. 1 million on the following:

1. A flat interest rate of 14%2. A hire purchase period of 36 months (3 Years)


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The total interest burden:

Rs 1000000 * 0.14 * 3 = Rs. 420000

Total amount:

Rs 1000000 + Rs. 420000 = Rs. 1420000

Monthly hire purchase installment

(Rs.1000000 + Rs. 420000) / 36 = Rs. 39444

Every Year :1420000 / 3 = Rs.473333


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Allocating the interest burden of Rs 420000 over the three years as

per the Sum Of The Years Digit Method.

1st Year:

Interest:

(12+11+10+..+1) / (36+35+34++1)

= 78 / 666

= (78 / 666) * 420000

= Rs.49189

Principal Repayment :

Rs.47333349189 = Rs. 424144


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2nd Year:

Interest:

(24+23+22++13 ) / (36+35+34++1)

=222/ 666

= (222 / 666) * 420000

= Rs.140000


Rs.473333140000 = Rs. 333333


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3rd Year:

Interest:

(36+35+34+..+25) / (36+35+34++1)

= 366 / 666

= (366 / 666) * 420000

= Rs.230811


Rs.473333230811= Rs. 242522


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Year Hire purchaseinstallment (Rs)

Interest (Rs) PrincipalPayment (Rs)

1. 473,333 49,189 424,144

2. 473,333 140,000 333,333

3. 473,333 230,811 242,522


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Lease vs. Hire

B i L Fi i Hi P h


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Basis Lease Financing Hire Purchase

Meaning Commercial Arrangement,whereby an equipment, owner

or manufacturer, conveys to the

equipment user the right to the

use equipment in return for a

rental.

Type of instalment credit under

which the hire purchaser

agrees to take the goods on hire

at a stated rental, which is

inclusive of the repayment of

principal as well as interest, with

an option to purchase

Option to user No option is provided to thelessee (user) to purchase the

goods.

Option is provided to the hirer

(user).

Nature of

expenditure

Lease rentals paid by the lessee

are entirely revenue expenditure

of the lessee.

Only interest element included in

the HP instalments is revenue

expenditure by nature.

Components Lease rentals comprise of2 elements (1) finance

charge and (2) capital recovery.

HP instalments comprise

of 3 elements (1) normal

trading profit (2) finance charge

and (3) recovery of cost of

goods/assets.


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THANK YOU

Documents

Lease vs Hire FM Final