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Lease finance and hire purchase are the options of financing the assets. These options vary from each other in many aspects viz. ownership of the asset, depreciation, rental payments, duration, tax impact, repairs and maintenance of the asset and the extent of finance.
Starting any business involves a lot of financial planning for acquisition of fixed assets like land, plant and machinery etc. Most entrepreneurs are scared of capital intensive projects due to huge financial commitments. When large capital is involved in the business, an entrepreneur wishes to spread his cost of acquisition of fixed assets over a longer period. A longer period would reduce per year commitment towards the cost of an asset.
The intention is to match the commitment with the revenue generated per year so that the payments are easily manageable without any cash flow mismatch.
Lease and Hire purchase is an exact solution to that kind of financial arrangement where the cash commitment is spread over the life of the asset and on the top, lease financing does not even require any initial capital outflow also. Hence under lease, the entrepreneur can use his capital for other working capital requirements.
In simple words, Lease is a financial contract between the business customer (user) and the equipment supplier (normally owner) for using a particular asset/equipment over a period of time against the periodic payments called “Lease rentals”.
The lease generally involves two parties i.e. the lessor (owner) and the lessee (user). Under this arrangement, the lessor transfers the right to use to the lessee in return of the lease rentals agreed upon. A lease agreement can be made flexible enough to meet the financial requirements of both the parties.
A lease also acts as an alternative for financing business assets. There are many options for a finance manager to choose from. He can opt for equity finance, debt finance, term loan, hire-purchase or many others. All the means of financing differ from each other due to their different characteristics. There are some advantages and disadvantages of leasing.
Hire Purchase is a kind of installment purchase where the businessman (hirer) agrees to pay the cost of the equipment in different installments over a period of time. This installment covers the principal amount and the interest cost towards the purchase of an asset for the period the asset is utilized. The hirer gets the possession of the asset as soon as the hire purchase agreement is signed. The hirer becomes the owner of the equipment after the last payment is made. The hirer has the right to terminate the agreement anytime before taking the title or the ownership of the asset.
Difference between Lease and Hire Purchase
Ownership of the Asset
In a lease, ownership lies with the lessor. The lessee has the right to use the equipment and does not have the option to purchase. Whereas in hire purchase, the hirer has the option to purchase. The hirer becomes the owner of the asset/equipment immediately after the last installment is paid.
In lease financing, the depreciation is claimed as an expense in the books of the lessor. On the other hand, the depreciation claim is allowed to the hirer in the case of hire purchase transaction.
The lease rentals cover the cost of using an asset. Normally, it is derived with the cost of an asset over the asset life. In the case of hire purchase, installment is inclusive of the principal amount and the interest for the time period the asset is utilized.
Generally lease agreements are done for longer duration and for bigger assets like land, property etc. Hire Purchase agreements are done mostly for shorter duration and cheaper assets like hiring a car, machinery etc.
In the lease agreement, the total lease rentals are shown as expenditure by the lessee. In hire purchase, the hirer claims the depreciation of asset as an expense.
Repairs and Maintenance
Repairs and maintenance of the asset in the financial lease are the responsibility of the lessee but in operating lease, it is the responsibility of the lessor. In hire purchase, the responsibility lies with the hirer.
The extent of Finance
Lease financing can be called the complete financing option in which no down payments are required but in the case of hire purchase, the normally 20 to 25 % margin money is required to be paid upfront by the hirer. Therefore, we call it a partial finance like loans etc.
Businessmen can opt option of lease finance or the hire purchase but they should be analyzed properly as to how much the option suits to the business requirement and situations.
A Summary of Tabular Presentation of Differences between Lease and Hire Purchase
|Points of Distinction||Leasing||Hire Purchase|
|Ownership||Lessor is the owner till the end of the agreement||Hirer has the option of purchasing the asset at the end of the agreement|
|Duration||Done for longer duration||Done for shorter duration|
|Depreciation||Lessor claims the depreciation||Hirer claims the depreciation|
|Payments||Rental payments are the cost of using the asset||Payments include the principal amount and the effective interest for the duration of the agreement|
|Tax Impact||Lease rentals categorized as expenditure by the lessee||Only interest component is categorized as expenditure by the hirer|
|Extent of Financing||Complete financing||Partial financing|
|Repairs and Maintenance||Responsibility of the lessee in financial lease, and of the lessor in operating lease||Responsibility of the hirer|