It is a method of financing assets in which they remain the property of the finance company that hires them and the lessee pays for the hire of the asset(s). The lessor charges a rent amount as a reward for doing it. The lessor has the asset ownership but the lessee has the exclusive use of the asset (subject to terms and conditions of the lease agreement).
These leases are either fully amortizing i.e.
- The rentals write the asset down to zero when the hire term expires or
- To a balloon rental (which may be equal to the estimated value of the asset at the hire term’s end.
A Finance lease substantially shifts all the risks and rewards linked to the ownership of the asset to the lessee. With the use of a finance lease, the asset appears on the lessee’s balance sheet with outstanding rentals represented as a liability.
Benefits of a Finance Lease Agreement
- Setting up of Regular Payments
- Minimal Upfront Cost
- Rentals are normally Corporation Tax deductible
- It has the potential to carry on using the asset when the lease period expires and
- Additional line of finance that may not affect core banking arrangements.
What happens at the Finance Lease End?
When the Finance Lease Contract is about to expire, you may be given an opportunity to extend it or return the asset to the financer, depending on the agreement terms and conditions. But in most situations, the lease extension option is provided at the end of the primary lease period. If the extension is not done, then the asset is returned to the company, to be sold further.
In other situations, the asset could be sold to a third party by the lessee. In such cases, the lessees’ acts on the behalf of the lessor and may be given a rental rebate equating to a part of the proceeds from the sale. All this is dependent on the terms and conditions in the finance lease agreement.
Read More: Finance Lease: Definition and Benefits