Financial Leasing Or Leasing What Is It And How Is It Accounted For?
Financial leasing or leasing is a contractual model that is very useful for companies or for the self-employed who cannot or do not want to make a large investment for the acquisition of a movable or immovable property necessary for the development of their work. It allows them to start production without having to contribute a large amount of capital.
Through this contract, a company assigns the use of a certain asset to another in exchange for periodic fees. In this article Global Leasing Alliance experts explain about Financial Leasing “it is a type of rental in which three actors intervene”:
• The supplier or distributor of the good: which is the one who sells it to the leasing company.
• The landlord: is the company or society that acquires the property and then rents it in exchange for a fee.
• The lessee (in this case a company or a self-employed person): makes use of this asset as long as it complies with periodic payments.
One of the most important characteristics of leasing or financial leasing is that, once the term stipulated in the contract has expired, the lessee has the option to buy that asset.
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Characteristics of the financial leasing or leasing
Financial leasing is distinguished from other contractual models by a number of characteristics. Among them are:
The good object of the contract can only be used for professional use.
The duration of the contract varies depending on the object of the contract: two years for movable property (machinery, computers, furniture) and 10 for real estate (land, buildings).
After the end of the contract, the tenant has three options:
1. Failure to exercise your right to purchase and return the asset to the financial institution.
2. Renew the lease agreement maintaining the same conditions or renegotiating them.
3. Exercise your right to purchase so that the property becomes your property.
During the term of the contract, the owner of the property is not responsible for its loss or deterioration.
The property must be insured against all risks.
Types of leasing
We can talk about three types of leasing:
1. Financial: It is the most common formula. In this case, the financial institution agrees to deliver the property but its maintenance is the obligation of the lessee. As we have already said, at the end of the contract, the customer can choose to purchase it. This type of contract can be subdivided into other categories:
Furniture financial leasing: Its minimum duration is two years.
Real estate financial leasing: This category includes the rental of commercial premises, industrial complexes, offices, land, etc. The minimum term of the contract is 10 years.
2. Operational: In this case, the use of the asset is transferred for a specified period and once this is over there is no option to purchase. Your turns to him for movable property financing. Its duration is shorter than in the other cases.
3. Leaseback: The lessee owns an asset that he sells to a leasing company. This in turn gives it to the first in lease. This contractual figure is usually used with real estate. This type of leasing is used to free up resources and be able to use them as working capital.
Main advantages and some disadvantages
Among the positive aspects of this type of contract, we find:
• Your tax advantages. The fees that the tenant pays are deductible in each of the years in which the contract is in force. It is not necessary to follow the repayment terms that are established for personal income tax.
• It allows the entrepreneur or freelancer to increase the productivity of their company without the need to make a large initial investment.
• The fees are usually flexible so they can be adapted to the needs and/or capacities of the company that acts as the tenant.
• You can buy all kinds of goods, both national and imported.
• Prevents company assets from becoming obsolete.
• Leasing allows the financing of an asset at 100%.
• Financial leasing operations are processed much faster than those related to bank loans.
Leasing operations also have a negative side. These are some of its disadvantages:
• Its cost is higher when compared to other financing operations.
• The good object of the contract cannot be returned until the end of the contract.
• It is not usual to include additional services in this type of contract. In other words, if the property suffers any damage, it will be the tenant himself who will take care of the repair costs.
• The cancellation of the contract carries a penalty.
How the finance lease is accounted for
The way of accounting for a leasing contract is similar to that of the acquisition of a fixed asset.
The lessee must register the assets according to their nature.
The financial liability of the same amount must also be recorded.
The total financial burden, that is, interest, must be distributed over the term of the lease and will be charged to the Profit and Loss account for the corresponding year.
It is important to establish the current value of the contract discounting the periodic installments and also the purchase option at the appropriate interest rate. It is necessary to take into account:
• The interest rate that is used is that which is specified in the contract. It may happen that this is significantly different from the average market rate. If this happens then the latter should be used.
• In the event that the current value of the contract exceeds the price of the good then the latter must be used.
• The nominal value of the contract must be accounted for as an enforceable liability.
• The difference between the nominal value of the contract and the current value of the contract must be recorded against an account called: Deferred leasing interest.