Day 10 The Financial leasing

The Financial leasing 

The financial leasing has shown its significance in company’s financial operation. As we know, leasing can be classified as two types.The operating leasing and the financial leasing. The core concept to differentiate them is that the financial leasing will substantially transfer all the risks and rewards incidental to ownership of an asset to the lessee. Which indicates during the economic life of the non-current asset, the lessee company will obtain all the profit created by it. However, the company also will be liable for the maintenance or other liability associated with the asset. 

Finance lease is a convenient tool in business’ borrowing procedure. It allows the business to lease the equipment with a more flexible financial option. Sometimes it is hard for business to acquire a bank loan, but financial leasing provides an alternative method to gain access to the profit generating asset. It eases off the burden on cash flow for the purchase of a non-current asset. In addition, the financial leasing has longer terms- usually the most of equipment’s entire economic life than other fund raising tools. Hence it decreases the risk on business solvency, because the large fair value is not required to be paid off in short term. Moreover, the lease of equipment let the business have the advantage on technology, due to the upgrade shall be available when the term ends. 

On the other hand, there are a few disadvantages for finance lease. Although the payment rate is fixed and stable, it still creates stress over the company’s financial position. The payment is continuous. Therefore, the business may face the financial problems, especially in slack season. Furthermore, the risks associated with the asset are binding with the company, so it is your responsibility to maintain its usefulness. Despite the fact you do not own the asset, these costly expenses are still your obligation. 

The assets under the lease are treated like purchase of non-current assets in accounting. Therefore, we need to capitalize the finance leased asset and establish finance lease liability. The amount is determined with its fair value or the present value of minimum lease payment. The repayment amount is divided into two parts, the current lease liability and the interest expense. So the present value is the accumulated lease liability excluded the impact of interest. Then we need to record the depreciation on the asset and calculate the interest expense, which is another part of the total repayment. 

Capital leasing is important and complicated, thus it is critical for us to understand it.