Equipment Leasing / Lease Financing
(Why Buy When You Can Lease? Finance Lease vs Operating Lease!)
A company needs a ₹20 lakh machine but can’t arrange capital. Solution? LEASE it! Pay rent, use the machine, and decide later whether to buy. This chapter covers lease types (Finance vs Operating), Ind AS 116, Wet/Dry lease, Sale & Leaseback, lease vs buy decision using NPV/IRR, and tax implications.
Banky Learns to Lease, Not Buy! 🏭🔑
An airline needs 5 new planes worth ₹500 crore each. Buy? Or lease? Leasing means no upfront capital, no ownership headache, and the airline gets to USE the planes immediately. But at what cost?
Leasing — Complete Guide
📖 Part 1 — What is a Lease? Key Terms & Types
Lease = Contract where LESSOR (owner) allows LESSEE (user) to use property for a specific period in exchange for LEASE RENTAL. Property can be land, building, equipment, vehicles — any asset.
4 Features: (1) Legal binding contract, (2) Guarantees lessee use + lessor regular payments, (3) Can be residential or commercial, (4) Breaking = legal consequences.
Ind AS 116: From ACCOUNTING perspective, only TWO types exist: Finance Lease and Operating Lease. Classification based on SUBSTANCE of transaction, not form of contract!
Other types: Leveraged (lessor borrows to buy asset, 3 parties: lessor/lessee/lender), Domestic vs International (cross-border = currency + country risk), Cancellable vs Non-cancellable, Wet (lessor operates + maintains) vs Dry (lessee does everything), Sale & Leaseback (sell your asset → lease it back → unlock value, ownership transfers but possession stays).
“Lessee has right to PURCHASE” is NOT a feature of a lease! That’s an OPTION in some finance leases, not a general feature. Exam trap!
📊 Part 2 — Finance Lease vs Operating Lease
Finance Lease (= Capital Lease): Transfers SUBSTANTIALLY ALL risks and rewards of ownership to lessee. Ownership may transfer at end. Lessee uses for MAJOR part of economic life. PV of minimum lease payments ≈ fair value. Specialised asset usable only by lessee. Cancellation losses borne by lessee.
Operating Lease: Does NOT transfer substantially all risks and rewards. Lease term substantially LESS than economic life. Lessee CAN cancel without substantial penalty. Like renting — short term, flexible.
Key test: Does it transfer substantially ALL risks & rewards? YES = Finance. NO = Operating. Look at SUBSTANCE, not form!
Accounting (Ind AS 116): For LESSEE — Finance & Operating treated SAME (both show right-of-use asset + lease liability on BS). For LESSOR — Finance & Operating treated DIFFERENTLY. Exception: Low-value assets and short-term leases (≤12 months) — lessee can just expense them.
Tax: LESSOR gets depreciation benefit (owner!). LESSEE gets tax shield on lease RENTALS. Lease attracts GST.
💰 Part 3 — Lease vs Buy Decision (3 Methods)
Compare lease with buying using borrowed funds. What changes: lose depreciation tax-shield, gain lease rental tax-shield, lose scrap value.
1. NPV Method: Calculate NPV of lease cash flows using post-tax borrowing rate. If NPV is NEGATIVE → buying is better. If POSITIVE → leasing is better.
2. IRR Method: Find discount rate where PV of lease cash flows = initial cost. If IRR > post-tax borrowing rate → buying is better (cost of lease too high).
3. Equivalent Loan Amount: Calculate how much loan the lease cash flows could service. If amount > asset cost → buying is better.
In the textbook example: ₹20L machine, 5 years, 8L annual rent, 25% tax, 10% post-tax rate → NPV of lease = −₹7.16L (NEGATIVE) → BUYING is better than leasing!
Exam-Ready Points
🎯 Must Remember!
- Lessor = owner. Lessee = user. Lease Rental = payment for use.
- Ind AS 116: Only 2 types — Finance & Operating. Classification by SUBSTANCE, not form.
- Finance Lease: Transfers substantially ALL risks & rewards. Ownership may transfer.
- Operating Lease: Does NOT transfer risks & rewards. Short-term. Cancellable.
- “Lessee has right to purchase” is NOT a general feature of lease! Exam trap!
- Wet Lease: Lessor operates + maintains the asset. Dry: Lessee does everything.
- Wet lease distinctive feature = LESSOR operates the equipment.
- Lessee accounting (Ind AS 116): Finance & Operating treated SAME (right-of-use + liability).
- Lessor accounting: Finance & Operating treated DIFFERENTLY.
- Low-value/short-term exception: Lessee can just expense (no BS recognition).
- Tax: Depreciation → LESSOR. Lease rental tax shield → LESSEE. GST applicable.
- Lease vs Buy: NPV, IRR, Equivalent Loan — all 3 methods available. Negative NPV = BUY.
- Lease agreement contains: Lease period + Transferability + Rental & payment terms — ALL.
- Leveraged lease: 3 parties — lessor, lessee, LENDER. Lessor borrows to buy asset.
- Sale & Leaseback: Sell asset → lease it back. Unlock value. Possession stays.
📝 Past Exam Questions
Last-Minute Flash Cards
⚡ Module C • Chapter 8 (Unit 26) Done!
- Lease: Lessor (owner) allows Lessee (user) to use asset for rental. Any asset.
- Ind AS 116: 2 types only — Finance (risks transfer) vs Operating (no transfer). Substance over form.
- Wet: Lessor operates. Dry: Lessee operates. Leveraged: 3 parties.
- Lessee accounting: Both types = SAME (Ind AS 116). Lessor = DIFFERENT.
- Tax: Depreciation → Lessor. Rental tax shield → Lessee. GST applicable.
- Lease vs Buy: NPV/IRR/Equivalent Loan. Negative NPV = buying is better.
Banky says: “Finance = almost buying! Operating = just renting! Wet = lessor operates! Depreciation → Lessor! Negative NPV = BUY don’t lease! Only 2 chapters left!” 🎉🏭🔑
Next: Chapter 27 — Working Capital Management! 💪