lease vs hire fm final
TRANSCRIPT
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Lease purchase andHire purchasePresented by:-
Group 5- 411,412,413,516,517,518
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Lease purchase
Rental agreement extending for year and more and has
series of fixed payments.
Alternative to buying
Involves two parties-Lessee-user
Lessor-owner (IBM)
Lessors-banks, Leasing companies(GE capital aviation
services)
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Lease contract
Legal contract enforceable to both the parties.
Names of the parties of the agreement.
The starting date and duration of the agreement.
Identifies the specific object being leased.
Specifies payment patterns
Provides options-purchase or take out new lease
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Types of leases
Operating lease
Financial lease types
Rental
lease(full
service)
Net lease Direct lease
Sale and lease
back
Leveraged
lease
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Advantages of lease
Leasing balances usage and cost
Leasing provides fixed rate financing
Leasing increases purchasing power
Tax shields can be used.
Leasing provides options
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Disadvantages of lease
No Ownership
Long Term Expense
Maintenance
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FINANCIAL LEASE
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A finance lease or capital lease is a commercial arrangement
where:
the lessee (customer or borrower) will select an asset(equipment, vehicle, software);
the lessor (finance company) will purchase that asset;
the lessee will have use of that asset during the lease;
the lessee will pay a series of rentals or instalments for the use
of that asset;
the lessor will recover a large part or all of the cost of the asset
plus earn interest from the rentals paid by the lessee;
the lessee has the option to acquire ownership of the asset (e.g.
paying the last rental, or bargain option purchase price)
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Impact on accounting
working capital decreases, but the debt/equity ratio
increases, creating additional leverage.
In a statement of cash flows, part of the lease payments
are reported under operating cash flow but part under
financing cash flow. Therefore, operating cash flow
increases.
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EXAMPLE
Blueline Bus Lines is considering a lease. Your operating
manager wants to buy a new bus for Rs.46 lakhs. The
bus has an 8 year life. The Bus Saleswoman says she will
lease Blueline the bus for 8 years at Rs.7.83 lakhs per
year, but Blueline assumes all operating andmaintenance costs. Should Blueline Buy or Lease the
bus?
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Cash flow consequence of the lease
contract offered to Blueline Bus:
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Blueline Bus can borrow at 10%, thus the value of the
lease should be discounted at:
.10 x (1-.3366)= 6.634%.
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Blueline Bus Lines lease cash flows
can also be thought of as loan
equivalent cash flows.
NPV= 40.80-40.86
= -0.06 lakhs
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Value of lease for lessor
2 3
4 5 6 7
906.53 809.76 737.18NPV lease = 4080.56
1.06634 (1.06634) (1.06634)
682.75 641.92 611.3 795.02
(1.06634) (1.06634) (1.06634) (1.06634)6.24 or Rs.6.24 thousands
The lessor can only win on lessee expense
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Other Types of leases
Capital Lease
(a) ownership at the end of the lease term;
(b) the asset at a bargain price;
(c) the lease term is equal to 75% or more of the estimated economic
life of the property
(d) the present value of minimum lease rental payments is equal to 90
% or more of the fair market value of the leased asset less relatedinvestment tax credits retained by the lessor.
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The first amendment lease
Gives the lessee a purchase option at one or more defined points with
a requirement that the lessee renew or continue the lease if the
purchase option is not exercised.
Full payment lease :
A lease in which the lessor recovers, through the lease payments, all
costs incurred in the lease plus an acceptable rate of return, without
any reliance upon the leased equipments future residual value.
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Sales type lease
A lease by a lessor who is the manufacturer or dealer, in which thelease meets the definitional criteria of a capital lease or direct
financing lease.
Trac
A tax-oriented lease of motor vehicles or trailers that contains a
terminal rental adjustment clause and otherwise complies with the
requirements of the tax laws.
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Blueline pays no tax
0 1 2 3 4 5 6 7
cost of new bus 4600
lease payment -783 -783 -783 -783 -783 -783 -783 -783
cash flow from lease 3817 -783 -783 -783 -783 -783 -783 -783
7
tt=1
783Value of lease = +4600 -
(1.1)
4600 - 4594.97 = +5.03, or Rs.5.03 thousands
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Operating Lease
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Operating Lease
An operating lease is similar to rent:
it is for a stated portion of time (less than the usefullife)
no ownership occurs from the relationship
rental costs are not directly associated with the
acquisition cost of an asset
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Usually not fully amortized. This means that the payments
required under the terms of the lease are not enough to
recover the full cost of the asset for the lessor.
Usually require the lessor to maintain and insure the asset.
Term: operating lease term is significantly less than the
economic life of equipment.
Lessee enjoys a cancellation option. This option gives the
lessee the right to cancel the lease contract before the
expiration date.
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Variety of lease plans
Variety of lease plans with differing add-ons or leave-outs
by different lessors but broadly falling into two categories:
Short term rentals .
Long term cancellable leases.
Full service leases
Net, but cancellable leases
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Features of an operating lease
Operating leases may not allow the asset to be virtually exhausted bythe same lessee.
Operating leases do not put the lessee in the position of a virtual owner.
The lease is either fully cancellable or partly non-cancellable and
partly cancellable.
Operating leases are non-full-payout.
The lessor may provide any services relating to the asset, such as
maintenance, or operations. In such case, the lease is wet lease.
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Example Page 706
SriramCompanys
Cost of vehicle (Limo) 3450
Other costs (op., insurance,
maintenance etc)
552
Useful life 6 years
Net salvage value 0
Depreciation rate 15%
Marginal tax rate 33.66%
Cost of capital 7%
Annual lease rental ?
h fl
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Cash flows
All the figures are in thousands
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Annual lease rental
1. Calculate the Present value of post tax cash
flows =
NPV= CF0 + CF1/(1+r) +CF2/(1+r)^2 +CF3/(1+r)^3CF4/(1+r)^4 + CF5/(1+r)^5+CF6/(1+r)^6
NPV= Rs 46.77 Lakhs
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Now Calculating the annual lease rental:
44.77= x + x/(1+0.07) +x/(1+.07)^2 +x/(1+0.07)^3
x/(1+0.07)^4 + x/(1+0.07)^5+x/(1+0.07)^6
X= Rs 9.17
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Operating Vs. Finance Lease
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HIRE PURCHASE
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WHAT IS HIRE PURCHASE?
Hire purchase is a type of installment credit under whichthe hire purchaser, called the hirer, agrees to take the
goods on hire at a stated rental, which is inclusive of the
repayment of principal as well as interest, with an option
to purchase.
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What are the income tax implications
in the case of a hire purchase?
In the hire purchase the hirer carrying business or profession
gets benefit of depreciation. He can also claim deduction on
the interest paid on hire charges, in his income tax
assessment.
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INDIAN CONTEXT- HIRE
PURCHASE ACT 1972 1) The owner delivers possession of goods thereof to a person
on condition that such person pays the agreed amount in
periodic installments.
2) The property in the goods is to pass to such person on the
payment of the last of such installments, and 3) Such person has a right to terminate the agreement at any
time before the property so passes.
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SC ARTICLE 7
SC=(NC*R*T)/100
NC (Net cash)
R (Rate 18%or less)
T (time between the date agreement is signed and last
payment is due
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SOLUTION
SC=(NC*R*T)/100 = (50000*18*5)/100=45000
HIRE PURCHASE CHARGES = 65000 + 45000 = 1,10000
BALANCE = 1,10000-15000 =95000
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ARTICLE 9- When Hirer tenders a
contract R =(SC*M*(M+1))/(N*(N+1))
M= No Of Complete Months still remaining
N=Total Number of months in the period
R=Rebate
SC=Statutory Cash Prize
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SOLUTION
R =(SC*M*(M+1))/(N*(N+1))
R=(45000*24*25)/(60*61)
7377.05 Rs.
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In case of breach
SC is hire purchase price is
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Accounting treatment
At the inception of the transaction, the finance company
should record the hire purchase installments receivables as
current asset (i.e. stock on hire)
the unearned finance income component of these
installments as a current liability under the head unmatchedfinance charges
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After end of Accounting Period
The hire purchase price less the installments received should
be shown as receivable / stock on hire
The finance income component of these installment should
be shown as current liability / unmatched finance charge.
The direct costs associated with structuring the transactions /deal should be either expensed immediately or allocated
against the finance income over the hire period.
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Cost Of Hire Purchase - HIRER
1. Down payment
2. + Service Charges
3. +Present value ofhirepurchasepaymentsdiscountedby the
cost of debt.
4. Present value of depreciation tax shield discounted by cotof capital.
5.Presentvalueofnetsalvagevaluediscountedbycostof capital.
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The NPV of HPP consist of
PVofhirepurchaseinstallments
+Documentationandservicefee.
+PVoftaxshieldoninitialdirectcost
Loan amount
Initial cost.
PVofinteresttaxonfinanceincome(interest)
PVofincometaxonfinanceincomemetedforinterest tax
PVofincometaxondocumentationandservicefee.
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HIRE PURCHASE & CONSUMER CREDIT
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Consumer Credit
Includes all asset based financing plans offered to individuals.
(eg. Cars, scooters,VCRs, TVs, Refrigerators, washing
machines etc., personal computers.).
Main supplier of consumer credit are Multinational Banks,
commercial banks, Finance cos..etc
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Consumer Credit...
Salient Features
Parties to the transaction : Bipartite arrangement - two
parties viz borrower/consumer and dealer/financier.
Tripartite Transaction - dealer, financier, and customer.
The dealer arranges the credit from the financier.
Structure of the transaction :
Hire-Purchase , Conditional Sale , Credit Sale .
Hire Purchase - Most tripartite consumer credit
transactions are of this type. Customer option to purchase
the asset on completion of the pay back period.
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Consumer Credit ...
Conditional Sale : Ownership not transferred until full
payment of purchase price, including the credit charge. The
customer cannot terminate the agreement.
Credit Sale : Ownership transferred to the customer on first
instalment payment. But the agreement cannot be cancelled.
Payment Period and ROI :
Payment period - 12 -60 months.
ROI - generally flat rate. Effective Rates generally not
disclosed. Sometimes in place of ROI, the EMI for different
payment periods is mentioned.
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Consumer Credit ...
Security :
First charge on assets. The consumer cannot sell the hypothecated
asset.
Evaluation
Can be made with Effective Rate of Interest and rebates for earlyrepayments.
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Installment Credit Systems
A system of customer financing, whereby the payments of the
purchase price is deferred, to be paid in reasonable installments
is known as installment credit systems.
Features:
An ordinary sale of goods with easy payment system
The buyer obtains ownership and possession on payment of the
first installment
Payment is made through a number of installment
No possibilities of the article sold being returned to the seller,
since sale is complete immediately after the execution of the
agreement
Hi P h d i ll
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Hire Purchase and installment
systemSimilarities:
1. They are forms of consumer finance for the sale of expensive and
durable goods
2. They are recognized by the Indian sale of goods act
3. Recovery of the price is through installments spread over a fixed
period of time
Suitability:
1. Separate identity or individuality to facilitate their recovery when
there is a default.
2. Durability to sustain the long period of installments and facilitaterepossession in the event of a default
3. High enough value to justify a hire purchase agreement
4. Standard specifications to facilitate reselling , if necessary
Example:
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Example:
Sum of the Years Digits
Nidhi finance offers a hire purchase proposal to one of its
customers, synthetic Chemicals, which requires an equipment
costing Rs. 1 million on the following:
1. A flat interest rate of 14%2. A hire purchase period of 36 months (3 Years)
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The total interest burden:
Rs 1000000 * 0.14 * 3 = Rs. 420000
Total amount:
Rs 1000000 + Rs. 420000 = Rs. 1420000
Monthly hire purchase installment
(Rs.1000000 + Rs. 420000) / 36 = Rs. 39444
Every Year :1420000 / 3 = Rs.473333
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Allocating the interest burden of Rs 420000 over the three years as
per the Sum Of The Years Digit Method.
1st Year:
Interest:
(12+11+10+..+1) / (36+35+34++1)
= 78 / 666
= (78 / 666) * 420000
= Rs.49189
Principal Repayment :
Rs.47333349189 = Rs. 424144
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2nd Year:
Interest:
(24+23+22++13 ) / (36+35+34++1)
=222/ 666
= (222 / 666) * 420000
= Rs.140000
Principal Repayment :
Rs.473333140000 = Rs. 333333
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3rd Year:
Interest:
(36+35+34+..+25) / (36+35+34++1)
= 366 / 666
= (366 / 666) * 420000
= Rs.230811
Principal Repayment :
Rs.473333230811= Rs. 242522
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Year Hire purchaseinstallment (Rs)
Interest (Rs) PrincipalPayment (Rs)
1. 473,333 49,189 424,144
2. 473,333 140,000 333,333
3. 473,333 230,811 242,522
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Lease vs. Hire
B i L Fi i Hi P h
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Basis Lease Financing Hire Purchase
Meaning Commercial Arrangement,whereby an equipment, owner
or manufacturer, conveys to the
equipment user the right to the
use equipment in return for a
rental.
Type of instalment credit under
which the hire purchaser
agrees to take the goods on hire
at a stated rental, which is
inclusive of the repayment of
principal as well as interest, with
an option to purchase
Option to user No option is provided to thelessee (user) to purchase the
goods.
Option is provided to the hirer
(user).
Nature of
expenditure
Lease rentals paid by the lessee
are entirely revenue expenditure
of the lessee.
Only interest element included in
the HP instalments is revenue
expenditure by nature.
Components Lease rentals comprise of2 elements (1) finance
charge and (2) capital recovery.
HP instalments comprise
of 3 elements (1) normal
trading profit (2) finance charge
and (3) recovery of cost of
goods/assets.
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THANK YOU