Before knowing the types of financial leasing, you must know the definition of what is financial leasing. Financial Leasing is the accounting procedure that companies use when acquiring assets with structured payments over a long period of time.
To give the proper definition, a financial lease can be expressed as the arrangement where the lessor receives lease payments from the lessee to cover the property’s costs. The landlord is responsible for maintenance, taxes, and insurance.
A financial lease is similar to a direct purchase transaction that has been financed by a term loan, since payments are made monthly. However, unlike a full purchase transaction in which the lessee does not present the obligated balance as debt, it shows the payments as expenses and retains the asset’s title.
During the period of a lease, the finance company is considered the legal owner of the asset. Leasing offers several benefits that can be used to attract clients. Among the main benefits are:
On the other hand, every one of the contracts is included in one of the four types of financial leasing that exist. We describe them below.
Four Types of Financial Leasing
Capital leasing is when an agreement is made through a long-term contract that is not cancellable. The lessee or the client is in the obligation to pay the rent of the lease until the expiration of the period of the same. Generally, the lease agreement corresponds to the useful life of the asset in question.
This is a long-term lease in which the lessee must record the leased item as an asset on its balance sheet and record the lease payments’ present value as debt.
Also, the landlord must record the lease as a sale on its own balance sheet. This type of lease can last for several years and cannot be canceled. It is treated as a sale for tax purposes.
Also known as the open lease, it meets a small difference to the capital lease because, in an operating lease, the lessee uses the asset for a specific period. The lessor assumes the risk of obsolescence and incidental risks. Also, there is an option for either party to terminate the lease after giving notice.
In this type of leasing, the lessor assumes all expenses. The lessor will also not be able to realize the lessor provides the total cost of the asset and the specialized services.
This type of lease is preferred when the asset is likely to become obsolete.
It is one of the leases that has become more popular in recent years and is known as a leveraged or unleveraged lease. It is used most of all when financing significant assets such as rail equipment, heavy machinery, aircraft, and oil platforms.
Unlike all other types of leases that exist, there are three base elements to carry out a leveraged lease agreement: the lessor, the lessee, and the lender.
The leased asset value can be of a large amount that may be impossible for the lessor to finance. Therefore, the lender or one more financier who will take over the leased asset is involved.
Sale and lease
In a sale and lease, a company that owns the asset sells it to the lessor. The landlord immediately pays for the asset but leases it to the seller. Therefore, the seller of the asset becomes the lessee.
The asset remains with the seller, who is a lessee, but the property belongs to the lessor who is the buyer. This agreement is made for the selling company to obtain financing to manage the business and the asset.
The owner company is required to make periodic rental payments to the landlord. This type of lease for sale and lease is very beneficial to both parties. While the lessor gets tax benefits due to depreciation, the lessee has an immediate inflow of money that improves liquidity.
The sale and lease have become very popular among companies that are in short-term liquidity crises happening only in registries without physically exchanging assets.
The transaction is made on paper and suitable for assets subject to appreciation rather than depreciation.