Sales

Leasing Types and Examples

Leasing, an old way of financing, is rapidly gaining popularity around the globe. The lease contract does not represent a sale or transfer of an object. It is a sale and transfer of the usufruct, which allows the object to be used for a specific period. It states that there are two parties to the lease contract. One is the owner of the asset or the lessor, and the other is the lessee (the party who takes the asset under lease). The lessee rents out the asset to be used for a specific period. While the lessor is the owner of the asset, it is in the ownership of the lessee. Also, the right to use the asset can be transferred to the lessee.

There are several types of leasing. These are the two main types of leasing: Operating Lease or Finance Lease. These are explained below.

(1) Finance LeaseFinance leases transfer all the risks and rewards associated with ownership to the lessee. Title or ownership may be transferred. A finance lease works in a similar way to a purchase agreement. Finance leases allow the lessee to purchase the asset after they have paid a set number of installments.

Example:

Imagine that the AB corporation leases a new car for three years. The AB company can also assume that after three years, the vehicle will be returned to them. The vehicle is not only leased, but the AB company also uses the lease agreement to finance the automobile. This is also known as finance lease or capital lease.

(2) Operating LeaseInternational Accounting Standard (17) states that an operating lease is not a finance or commercial lease. Operating leases allow the lessor to grant the lessee the right to use the asset/property for a specific period of time. However, the lessor retains the risks and rewards associated with ownership.

Example:

Let us suppose that MY enterprise has a complete 6th Floor in Eden Tower, which is a multi-story building. Let’s also assume that MY enterprise leases some rooms on this floor to XY corporation.

If the building’s value increases due to business activity, then the lessor, i.e. MY enterprises, can either sell the rooms or increase the rental amount. If the building’s value decreases, then MY enterprises will also be affected. This is known as operating lease.

Below are some examples of other types.

(3) Leaseback and Sale: An asset can be first sold to a financial institution under a sale and leaseback agreement. The real market value is used to determine the price of the sale. The asset is then leased back to the buyer. This type lease is ideal for companies who do not wish their financial statements to reflect high levels of debt.

(4) Capital Lease This type is governed by Pakistan’s financial standard board. When a lessee leases an asset, he simultaneously recognises it as a debt in the financial statement.

(5) Leveraged lease: This type of leasing involves three people: a lender and a lessor. Lender and lessor collaborate to acquire funds to buy the asset. The asset is then given to the lessee on a lease. The lessee pays periodic rent to the lessor, who then makes payments to the lender.

(6) Cross Border Leasing This means that you can operate a lease agreement in another country. In today’s circumstances, such leasing is difficult. Foreign countries have different tax rules, accounting methods and related criteria. The tax rules vary from one country to the next. This creates a problem when it comes to how to present a lease agreement in a financial statement.

As with all recent developments, the accounting treatments for each item are being made identical by International Accounting Standards. It is hoped cross-border leasing can flourish in the near future.

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