There are various options available in a business to finance its assets. It may be an operating lease, financial lease or installment sale and a host of others. However, in making decisions, the financial and accounting implications should be taken into account.
Leasing is a practice which allows a person to use the asset for an agreed period of time against payment of lease rentals. At the end of the term, the lessor can sell the asset to a lessee or terminate/extend the agreement as per mutual consent.
Majorly, there are two types of lease transactions:
This type of lease is long-term in nature and is continued till the economic life of the asset. The cumulative lease rental payments throughout the contract are greater than the initial cost of the asset. Examples are: Taking a building or factory on a lease.
This type of lease is short-term in nature and is generally for a specific period which is much less than the economic life of the asset. The total lease rentals during the leased period do not exceed the cost of the leased asset. Hiring a car, for instance, is an example of operating lease.
An installment sale is one of the finance facilities to buy vehicles or other assets in exchange for a specified series of payments. The ownership transfers at the end of the credit agreement. It may or may not include interest. It carries certain tax advantages i.e.
It can be used for all types of properties, except:
- Securities traded in exchange markets.
- Property for sale in the ordinary course.
Lease Finance Vs Installment Sale
Nature: Installment sale is a sale whereas lease financing is a type of rental contract with a purchase option between the two parties.
Ownership of the Asset
In an installment sale, the ownership transfers to the user at the end of the installment period. Whereas in a case of lease financing, the lessee has to transfer the asset to the lessor after the end of the lease period and the lessee has an option to purchase or not to purchase the asset.
The total deduction for taxation purpose is same for leasing and installment sale. However, in the case of leasing, it takes twice as long to write off the asset as compared to an installment sale. The depreciation is claimed by the lessor in lease financing whereas, in an installment sale, the user claims the depreciation.
Balance Sheet Appearance
In lease financing, the value of the asset is not included in the financial statements since the lessee is not the owner. Whereas in the case of installment sale, the installments are capitalized i.e. the asset appears on the asset side of the balance sheet and a corresponding liability against such asset appears on the liability side.
Overall Cost of the Asset
The cost of the asset in case of lease financing is the cost of using the asset over its life. In the case of installment sale, installment includes the principal amount and the interest for the term till the last installment is paid.
Generally, leasing is suitable for longer periods and for assets like land, property, heavy vehicles and huge plant and machinery. An installment sale is done for short periods and for assets like light moving vehicles, electrical items, small machinery etc.
Maintenance Support of the Asset
In the case of operating lease financing, the repairs, and maintenance of the asset is borne by the lessor and in the case of the financial lease, it is borne by the lessee. In an installment sale, the responsibility lies with the user.
Reduced Initial Cash Outlay
Since there is no immediate purchase of an asset in an installment sale, the cash flow is limited up to the margin money i.e. the down payment or the deposit as it is so called in addition to the periodic installments. In the case of lease financing, the monthly rentals are the only cash flows during the entire usage life of the asset.
It is, therefore, necessary to know the consequences while dealing with lease transactions and installment sales. The person should analyze the options with a different outlook. The economic viability of the transactions along with the entries in financial statements shall be according to the specified acts and rules. Also, the income tax consequences, as well as the VAT consequences, should not be overlooked.