A finance lease is a lease agreement between lessor and lessee where the ownership of the asset is transferred to the lessee at the end of the lease term. A finance company is a lessor where as individual or borrower or customer is a lessee. “Capital Lease” is another term used for Finance Lease.
Features of Finance Lease/Capital Lease
- Finance Company (Lessor) purchase the asset on behalf of the borrower (Lessee)
- Lessee uses the asset during the lease period.
- Finance company (Lessor) recovers a large part or almost complete cost of the asset along with some interest benefit.
- Lessee pays a series of installments or rentals for using the asset.
- Borrower (lessee) has the option of acquiring ownership of the asset.
Classification of lease as Finance Lease
- Lease term is greater than 75% of the total economic asset life.
- Lease rental expenses should be greater than 90% of MV of leased asset.
- Lessor is not the legal owner till the end of terms & can either purchase the asset at a price less than fair market value.
Advantages of Finance Lease
- Finance lease allows business customers to use an asset without buying it.
- Borrower (Lessee) pays installments of the cost of the asset rather than a large upfront investment.
- In finance lease, the repayment structures are flexible and available. It can be tailored as per the need and capacity of the borrower.
- The amount paid by the lessee is spread over the period of time in the form of fixed installments.
- Lessee is allowed to claim depreciation on the asset, which reduces taxable income.
Disadvantages of Finance Lease
- Lessee has the responsibility to maintain and look after the asset hence, lessee incur some additional maintenance expenses.
- All the risks associated with the asset is borne by the lessee. In finance lease, the risk is transferred to the lessee.
- Finance lease involves a lot of documentation and other formalities.
- In finance lease, lessee is creating excess debt in its balance sheet.
- In case of bankruptcy, protection is not granted to leased asset.