Lease and its classification

 

Lease: using an asset by paying rent. Example: CNG driver takes CNG from the owner for a particular period by paying rent.

There are five classification of loan.

1.       Operating lease

2.       Capital lease

3.       Sell and lease back

4.       International lease

5.       In-house lease

Operating lease: It is a short term lease. Example renting a room for 3 months. Maintenance cost will be provided by lessor/borrower. In case of operating lease ownership will never be moved. In Bangladesh, operating lease is not used by any financial organization.

Capital lease: Financial Accounting Standard Board (FASB) stated that if present value of future rent is equal to 90% cost of asset it is called capital lease or if single person will use 75% of the asset, this is  called capital lease or increase of selling the leased asset if lessee will get the priority to buy, it is called capital lease. It is a long term lease. In case of capital lease, maintenance cost will be provided by the lease/borrower. Ownership will be moving to the lessee subject to giving all rents.

Difference between Operating lease and capital lease

1.       Operating lease is for short term

Capital lease is for long term.

2.       In case of operating lease maintenance cost will be provided by the lessor or the owner.

In case of capital lease maintenance cost will be provided by the lessee or the borrower.

3.       In case of operating lease ownership will never be moved

In case of capital lease ownership will be moving to lease subject to giving or paying all rents.

4.       Example of operating lease: renting a room for 3 months.

Example of capital lease: Leasing a car for 5 years.

Why operating lease is not used in Bangladesh?

1.       Absence of workshop of the leasing companies that is maintenance problem.

2.       Lack of gentle human behavior. Trust issue with the borrower or lessee. The lessee may use the machine roughly.

3.       Continuation of the use of the asset.

Solution

1.       Outsourcing the workshop facility from another company. Example: IDLC can outsource workshop facility from Navana.

2.       Operator must be provided from the lessor’s part to ensure proper maintenance.

3.       Strong website should be developed for the user so that they can order the asset by using virtual platform.

Benefit of leasing

1.       In case of loan the borrower has to pay equal monthly installment or EMI which includes both interest and principal amount. But only interest amount is treated as expense here. As a result the profit become high as well as tax is also become high.

But in case of lease, the lessee has to pay rent, which is treated as expense. Because of higher expense the profit become lower which results in lower tax. So, in case of leasing the borrower gets more tax benefit.

2.       In leasing full payment is not required at a time. The lessee can pay the amount by monthly rent.

3.       For the customers who follow Sariah law, lease is appropriate for them. Because according to Sariah law interest is haram but rent is halal.

Sell and leaseback

Where an owner of an asset sells it and then lease it back from the new owner. For example, Labaid have a machine. They sell it to IDLC for money and after that Labaid will lease the machine from the IDLC and paying rent. After the payment of rent they will be the owner of that machine again. In that case the machine will not move from Labaid.

Advantage of sell and leaseback

1.       Solving liquidity: Through sale-leaseback condition, owner get huge amount of money at a time. This amount may increase the working capital which helps to pay due amount to supplier or helps to expand the business.

2.       Opportunity to get back asset: Seller can get his/her asset back after the respected maturity period.

3.       No production interruption: Since sold machine does not take away by new owner. So, seller can use the machine as before. As a result, Production does not interrupt. 

4.       Reduction in tax liability: This works in two ways. The company which has now sold the asset and has it on lease, does not have to pay tax on any appreciation of the asset and rent outlet will reduce the profit in the profit and loss statement which in turn reduce tax liability.

International lease: It can be both operating or financial lease. Example, Pakistan borrows submarine from America for nine months. It was an operating lease.

In-house leasing: Both organization owned by group. Example: Uttara finance will buy the car from Uttara motors and give lease to the buyer or lessee and the lessee will pay the rent and after paying all the rent, lessee will be the ultimate winner. It is called in-house leasing because Uttara motors and Uttara finance are the same company. Leasing is the strong marketing tool. Through the leasing, the sale of the Uttara motors will increase and ultimately the company become benefitted.