Leasing and Hire Purchase: Industry, Size and scope, Parties involved

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Leasing and Hire Purchase: Detailed Explanation

Assets

  • Definition: Assets are anything of monetary value that is owned by a firm or individual. They are listed on a firm’s balance sheet and can include both tangible items like inventories, equipment, and real estate, and intangible items such as property rights and goodwill.

Leasing

  • Definition: Leasing is a financial arrangement where the lessee (user) pays for the use of an asset owned by the lessor (owner) over a specified period. Unlike purchasing, the lessee does not gain ownership rights.
  • End of Lease Options:
    • Extend the Lease: Continue using the asset under a new agreement.
    • Return the Asset: Give the asset back to the lessor.
    • Introduce a Buyer: Find a buyer for the asset. The lessee may get a refund (up to 95% of sale proceeds, depending on the contract).
  • Accounting and Tax:
    • Finance Lease: Treated as a loan, with lease payments considered as loan repayments. Tax treatment follows the legal form (hiring of an asset).
    • Operating Lease: Treated as rental expenses, allowing lessees to expense the lease payments.
  • Common Uses: Leasing is prevalent in industries requiring expensive machinery, such as construction, manufacturing, plant hire, printing, road freight, transport, engineering, and professional services.
  • Costs:
    • Interest Rates: Higher resale value assets (e.g., machinery, agricultural equipment, vehicles) get favorable rates. Lower resale value assets (e.g., printers, vending machines, office furniture) get less favorable rates.
    • Fees: Processing and administrative fees apply. Example: Regular servicing requirements for cars purchased on HP.
  • Timeframe: Completing a leasing or HP agreement typically takes up to a week, depending on the deal’s size and complexity.
  • Advantages:
    • Capital Management: Enables asset use without significant working capital outlay.
    • Fixed-Rate Funding: Simplifies budgeting with predictable expenditures.
    • Flexible Repayments: Options for seasonal businesses, such as annual repayments or balloon payments at the term's end.
    • Depreciation Risk Mitigation: Protects against asset value depreciation and allows for contract renewal.
    • Tax Efficiency: Lease payments can be booked as expenses. Depreciation also offers tax benefits, depending on the asset’s lifespan and local regulations.
    • High Accessibility: Secured by the leased asset, making financing more accessible.
    • Maintenance: Some agreements include asset maintenance.
  • Disadvantages:
    • Higher Total Payments: Overall capital payments exceed the outright purchase price.
    • Administrative Complexity: Greater administrative costs and complexity, especially if covenants are applied.
    • Early Termination Charges: Fees may apply if the business strategy changes, rendering the asset redundant.
    • Subleasing Restrictions: Early termination or subleasing restrictions can apply.

Hire Purchase (HP)

  • Definition: Hire Purchase is a financing arrangement allowing businesses to purchase assets without immediate full payment. An initial deposit is followed by balance and interest payments over time. Ownership transfers upon final payment.
  • Features:
    • Installment Payments: Rental payments spread over the agreement period.
    • Asset Repossession: Seller can repossess the asset if the hirer defaults on payments.
    • Hire-Purchase Agreement: Documents all terms and conditions.
    • Installment Frequency: Payments can be annual, half-yearly, quarterly, monthly, etc., based on the agreement.
    • Immediate Asset Delivery: Assets delivered as soon as the agreement is signed.
    • Ownership Transfer: Assets transfer to the hirer after the last installment.
    • Return Option: Hirer can return the asset anytime, ceasing further payments.
    • Non-refundable Payments: Payments made are non-refundable as they cover asset hire and use.
    • Restriction on Pledging/Selling: Hirer cannot pledge, sell, or mortgage the asset until full payment is made.
    • Initial Deposit: Typically required at agreement signing.
    • Agreement Termination: Hirer can terminate the agreement before ownership transfer.
  • Common Uses: Suitable for acquiring expensive machinery, smaller items, cars, and photocopiers.

Summary

  • Leasing: Provides asset use without ownership, allowing for flexible financial management and tax benefits. It can be costlier over time and administratively complex.
  • Hire Purchase: Enables asset ownership through installment payments, offering immediate use but higher total costs and potential contractual restrictions.