Author: Jim Riley Last updated: Sunday 23 September, 2012
Introduction to hire purchase and leasing
The acquisition of assets - particularly expensive capital
equipment - is a major commitment for many businesses. How that acquisition
is funded requires careful planning.
Rather than pay for the asset outright using cash, it can often make sense
for businesses to look for ways of spreading the cost of acquiring an asset,
to coincide with the timing of the revenue generated by the business.The most
common sources of medium term finance for investment in capital assets are
Hire Purchase and Leasing.
Leasing and hire purchase are financial facilities which allow a business
to use an asset over a fixed period, in return for regular payments. The business
customer chooses the equipment it requires and the finance company buys it
on behalf of the business.
Many kinds of business asset are suitable for financing using hire purchase
or leasing, including:
- Plant and machinery
- Business cars
- Commercial vehicles
- Agricultural equipment
- Hotel equipment
- Medical and dental equipment
- Computers, including software packages
With a hire purchase agreement, after all the payments have been made, the
business customer becomes the owner of the equipment. This ownership transfer
either automatically or on payment of an option to purchase fee.
For tax purposes, from the beginning of the agreement the business customer
is treated as the owner of the equipment and so can claim capital allowances.
Capital allowances can be a significant tax incentive for businesses to invest
in new plant and machinery or to upgrade information systems.
Under a hire purchase agreement, the business customer is normally responsible
for maintenance of the equipment.
The fundamental characteristic of a lease is that ownership never passes
to the business customer.
Instead, the leasing company claims the capital allowances and passes some
of the benefit on to the business customer, by way of reduced rental charges.
The business customer can generally deduct the full cost of lease rentals
from taxable income, as a trading expense.
As with hire purchase, the business customer will normally be responsible
for maintenance of the equipment.
There are a variety of types of leasing arrangement:
The finance lease or 'full payout lease' is closest to the hire purchase
alternative. The leasing company recovers the full cost of the equipment,
plus charges, over the period of the lease.
Although the business customer does not own the equipment, they have most
of the 'risks and rewards' associated with ownership. They are responsible
for maintaining and insuring the asset and must show the leased asset on their
balance sheet as a capital item.
When the lease period ends, the leasing company will usually agree to a secondary
lease period at significantly reduced payments. Alternatively, if the business
wishes to stop using the equipment, it may be sold second-hand to an unrelated
third party. The business arranges the sale on behalf of the leasing company
and obtains the bulk of the sale proceeds.
If a business needs a piece of equipment for a shorter time, then operating
leasing may be the answer. The leasing company will lease the equipment, expecting
to sell it secondhand at the end of the lease, or to lease it again to someone
else. It will, therefore, not need to recover the full cost of the equipment
through the lease rentals.
This type of leasing is common for equipment where there is a well-established
secondhand market (e.g. cars and construction equipment). The lease
period will usually be for two to three years, although it may be much longer,
but is always less than the working life of the machine.
Assets financed under operating leases are not shown as assets on the balance
sheet. Instead, the entire operating lease cost is treated as a cost in the
profit and loss account.
Contract hire is a form of operating lease and it is often used for vehicles.
The leasing company undertakes some responsibility for the management and
maintenance of the vehicles. Services can include regular maintenance and
repair costs, replacement of tyres and batteries, providing replacement vehicles,
roadside assistance and recovery services and payment of the vehicle licences.
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