Leasing is a contract between one party called lessor (owner of asset) and another called lessee where the lessee is given the right to use the asset (without legal ownership) and undertakes to pay the lessor periodic lease rental charges due to generation of economic benefits from use of the assets. Leases can be short term (operating leases) in which case the lessor incurs the operating and maintenance costs of the assets or long term (finance leases) in which the lessee maintains and insure the assets.
Lease finance is ideal under the following conditions:
- When the asset depreciates faster.
- When the asset is subject to obsolescence
- When the available asset cannot meet the contemplated expansion program
- When the asset’s cost is prohibiting
- If the asset is required seasonally
- If the asset can generate returns to pay off lease charges in the short run
Advantage of Leasing an Asset
1. It does not tie up the company’s funds in an asset.
2. The arrangement may ensure lessor bears the maintenance costs reducing the companies operating costs.
3. The company has the option to purchase assets at the expiry of the lease period at which time it will know the viability of the asset.
4. The company (lessee) will enjoy the lease charges as allowable expenses thus reducing taxable income and tax liability.
5. Lease finance enables the lessee to use the asset to create financial surpluses which may then be used to buy assets.
6. It is usually a long-term arrangement which enables the company to plan returns expected and operations which may be carried out.
Disadvantage of Leasing an Asset
1. It is a pre-conditional finance (as on the use of asset)
2. In the long term the lease charges may out-weigh the cost of buying own asset.
3. It is available for a selected asset and this limits flexibility.
4. It is useful for financing fixed assets and not working capital
5. Lease finance may not be renewed leading to loss of business.
6. Lease financing lowers the company’s credit rating (i.e. the asset in the balance sheet is shown as leased asset).