Leasing is a contract between two parties where one party known as the lessor (owner) gives another party known as the lessee the right to use an asset upon payment of periodic lease rentals.
Classification of leases
- Operating lease
- Finance / capital lease
- Sale and lease back
- Leveraged lease
(i) Operating lease
This when the asset is leased for a short period of time e.g hiring a tractor to plough a piece of land. It has the following features;
- Lease period is very short relative to economic life of the asset
- Contract can be cancelled by either party before the end of lease contract.
- Lessor incurs maintenance, operating and insurance expense on the asset.
- Lessee is not given an option to buy the asset at the end of the lease period.
(ii) Finance / capital lease
It’s a long term in nature and the lease period is almost said to the economic life of the asset. It has the following feature;
- Lease period at least 75% of the economic life of asset.
- Lease contract can’t be cancelled by either party before end of lease period.
- The lessee incurs maintenance operating and insurance expenses on the asset.
- Lessee given an opportunity to buy asset at end of period at low cost.
(iii) Sale and lease back
This is where the company sells existing asset then leases back from the new owner hence retaining the asset. The company then becomes the lessee and it starts to pay lease rentals to the new owner.
(iv) Leveraged lease:
This is where asset being leased by the lessor still has some outstanding financial obligation. It involves three parties’ lessor (borrower) lessee (tenant) and financier (lender). The financier and lessor will jointly finance acquisition of asset periodic lease rentals, used to pay loan from the financier.