question_answer

What is lease financing? Discuss its merits and demerits.

Answer:

Ans.     A lease is a contractual agreement, in which the owner of the asset grants the other party the right to use the asset in return for a periodic payment, but retains the title over the property. The owner of the asset is called lessor and the party who uses the assets is called lessee.

Lessee pays a fixed periodic amount to the lessor. It is called lease rent. When period of lease expires, the asset is returned to the lessor. It is used more frequently with items like computers and electronic items which become obsolete soon. Leasing company (lessor) owns the equipment and hires it out to the customers (lessee pays rental income to hire assets). It is a medium term fund. New companies need expensive equipments to run the business: office, equipment leasing from larger companies like Apple.

Merits of Lease financing

1. It allows the lessee to acquire the asset with lesser investment.

2. Simple documentations makes it easier to finance assets.

3. Lease rentals get tax advantage as they are deductible for computing taxable profits.

4. It reduces initial capital for (new) businesses.

5. It provides added service: maintenance and upgrading.

6. It makes funds available without diluting the ownership of business.

7. The lease agreement does not bring any change in raising capacity of an organization.

8. The risk of obsolesce is borne by the lessor.

Demerits of Lease Financing

1. A lessee agreement imposes restrictions on usage of assets. For example, alternation and modification in assets may not be allowed.

2. The normal business operations may be affected if lease is not renewed.

3. It may result in higher payout obligations in case the equipment is not found useful and the lessee chooses for premature termination of the lease contact.

4. It never makes lessee the owner of the asset.