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Leasing, a Modern Financing Alternative

Updated on August 20, 2011

Leasing defined

Leasing is nothing more than a method of paying for the use of an asset (like road vehicles, construction machinery, printing presses, complete factories etc.) over a specified period of time. Sounds like renting, but don't get the two confused because they are very different. Where you can rent a car for as little as a day, or even a few hours, leasing typically starts at 24 months.

In other words, leasing operations are those operations by which a party (named lessor/financer), undertakes to transfer for a determined period of time, to another party (named lessee/user), at the request of the last one, the right to use an asset for a period of time against a regular payment called royalty.

The owner of the asset is the lessor. At the end of the leasing period the lessor undertakes to observe the right of option of the lessee to acquire the asset, to extend the leasing contract or to terminate the contractual relations. The lessee may express his option for buying the asset prior to the end of the leasing period, if the parties agreed upon it in the contract and if he paid all his contractual obligations.

Read about the differences between leasing and credit.

The leasing contract and the role of the parties involved

The leasing contract is that contract through which the lessor/financer/ locator transfers for a determined period the usage right over a good whose owner is, to the user/lessee, at the request of the latter, in exchange of the leasing rate.

There are four main parties involved in the lease operations:

a. the lessor/the financer

b. the lessee/the user

c. the supplier

d. the insurance company

The lessor is the party that possesses the legal ownership of the equipment subject to leasing and that transfers the usage rights of the equipment to the lessee against the rentals determined in advance by the contract. The financer can be a leasing company, or a foreign legal person.

The lessee is the party that purchases the usage rights of the equipment in leasing transactions against the rentals determined in advance by the contract. The user can be any local or foreign, legal or natural person.

During the leasing operation the user can choose, if the leasing company agrees, the supplier as well as the insurance company. The supplier is the manufacturer or the marketing company providing the equipment subject to the leasing contract.

The insurance company is the party covering the risks of the issued goods that are insured.

Types of lease operations

There are several factors that should be taken into consideration while classifying the lease operations, like the period, the parties and the way of computation.

• The following classification is based on the extent to which the risks and rewards due to the property title over a good under a leasing regime go to the lessor or to the lessee. We can therefore distinguish two types of leasing:

- financial leasing

- operational leasing

The risks include the possibility of incurring due to a low degree of usage of the good and the obsolescence as well as to some variations in the income (due to changes in the economic environment).

The rewards can be represented by the evaluation of a profitable activity over the economic life of the good and some gains from the increase in value or from realizing the residual value.

In case of an operational leasing contract the good remains the property of the leasing company after the end of the contract.

Another difference between the two types of leasing is given by the deductibility of the expenses associated with the leasing contract. While in case of the financial leasing the lessee can deduct only the interest expenses and the depreciation expenses, for the operational leasing he can deduct the entire leasing installment (value of the good plus interest).

Thus, at first sight the operational leasing contract seems much more advantageous than the financial one, but these advantages are reduced because of the fiscal implications for the leasing company. For the leasing company, the entire installment for an operational leasing contract is considered as revenue and taxed as such. By consequence, in order to maintain their profitability the leasing companies apply a higher interest rate for the operational leasing than for the financial one.

Regarding the transfer of risks, in case of operational leasing the risks are retained by the leasing company, which resembles the operational leasing to renting. This is one of the main reasons why leasing companies are not very enthusiastic about operational leasing.

• Another classification of the lease operations is based on the period of the lease:

- Short-term leasing (renting, hire)

- Medium-term leasing (equipment leasing)

- Long-term leasing (plan leasing)

The short-term lease consists in renting the goods for a few hours, days or months, in order to depreciate them.

The medium-term lease consists in depreciating the good by renting it consecutively to more users on short term like 2-3 years.

The long-term lease is frequently used on the real estate market and for completely equipped buildings, the duration being of 20-30 years.

• Another classification is the one based on the parties of the contract:

  • direct leasing
  • indirect leasing

The direct leasing represents the type of leasing where the lessor is also the supplier.

The indirect leasing represents the type of leasing where the financing is made by a specialized (intermediary) company.

• According to the features of the market and the relations with the clients, some special forms of leasing have developed, like:

- lease-back

- experimental leasing

- time-sharing

- personnel leasing

- master-leasing

The lease-back represents a hidden form of financing for a commercial company. In short, this operation consists of: the user sells a good to the leasing company that afterwards leaser from the latter, this was reimbursing through the lease installments the „credit" (equal to the selling price of the good). A sale and leaseback transaction involves the sale of a good by the seller and leasing to the seller the same good under leasing regime. The lease payments and the selling price are usually interdependent, because they are negotiated together.

The experimental leasing consists of renting the goods over short periods, followed by their selling if they are according to the user's requests.

The time-sharing represents a lease over several periods of time. It is usually used in tourism for leasing the material basis and in the case of IT and means of transportation.

The personnel leasing has as object the lease of personnel over a short period of time (a day or several days). In Western countries, the temporary way of work is also used by persons who already have a permanent job but who want to supplement their income.

The master-leasing is a special form of leasing used for renting containers. In its turn it is of two types:

trip-leasing - for the whole period of the trip -and term-leasing - for term renting.

Read more about advantages and disadvantages of leasing.

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