Leasing a vehicle

Essentials

Leasing contract made by 3 parties - the Seller of the item, Lessor (leasing company) and Lessee (company renting item from Lessor). A leasing contract is a commitment of a Lessor (leasing company) to purchase a vehicle chosen by Lessee and give it to Lessee for paid temporary use. At the end of the leasing agreement, the Lessee is eligible to buy out the truck or machinery for the residual value (often zero or close to zero amount). The principal point of leasing agreement is that Lessor remains the owner of the rented item until it is bought out by Lessee.

The key elements of the leasing process include the contract value of the machinery, also known as capital cost (this is the purchase price, paid for the vehicle by a leasing company, which sets the amount of the following leasing payments) and the total contract cost (consists of all the payments from the customer to the benefit of a leasing company: initial rental, terminal payments, residual value). A leasing agreement always conforms to a definite contract period. It starts when the transport means is transferred to the customer for its further exploitation and continues until either the full settlement or the residual value is paid.

Why is leasing profitable for all the sides involved? As for the buyers, they benefit from saving their working assets, they don't need to spend a significant sum of money. Instead, they are able to make unlimited use of the vehicle right away after paying the agreed initial advance payment.

A leasing company immediately rents the acquired vehicle to the customer for amount that was paid for the vehicle plus determined interest called a leasing fee. For instance, the customer has found a commercial vehicle seller and agreed to purchase a truck with a trailer with total cost of 100.000 Euro. The leasing company buys this truck for the mentioned price and immediately rents it to the customer on the following terms: the initial advance payment of 40% and the fixed monthly payments of 2200 Euro during 36 months without zero residual value. The customer immediately receives a new vehicle at the disposal, but instead of paying 100.000 Euro at a time, they pay only 40.000 Euro of advance payment and commit to pay 2200 Euro each month for the period of 36 months. It turns out that this leasing company has spent 100.000 Euro, but in 3 years they will get the total of 119.200 (advance payment 40.000 + 2200*36 months). And the customer has initially spent only 40% from the total vehicle value and after paying off all the fixed payments in 3 years, becomes the vehicle owner.

Thus, a leasing fee is a Lessor's interest for financing the Lessee.

All the leasing payments include depreciation (i.e. the contract value is divided into the definite sums according to the payment periods) and a leasing fee. The leasing payments are made in accordance with the defined leasing payments schedule. The amounts can be equal or have an ascending/descending/seasonal character, depending on the terms of the leasing agreement. Meanwhile, the object of the contract is not liable to revaluation during the leasing period.

With regard to the exploitation tasks of the leasing objects, there are the following types of leasing agreements:

1. Financial leasing. It is discussed in the above mentioned example. According to this type, the vehicle cost is paid regularly for a fixed period of time. It is similar to an installment scheme but includes payment of interest - a leasing fee.
2. Leaseback. It means that the object of leasing is already owned by the customer, who first sells this unit to a leasing company, then rents this same unit for leasing fee, and finally buys it out at the end of the contract. By means of such a scheme, the customer immediately gains additional working assets, still making use of the leased unit.
3. Operative leasing. This type involves partial compensation (which is usually no more than 75%) of the property value during the valid contract period. At the end of this period, the leased assets should be returned.

Leasing or bank credit?

Actually, leasing is quite similar to bank financing. However the main difference is in the source for interest payments. The interest on a bank credit is paid from a company’s profit, while the interest on accounted from the production cost (which is very beneficial for a customer as the tax base for tax calculation is reduced this way).

Some significant advantages in the favor of leasing:

• There is no need to purchase the machinery in order to use it and get the revenue.
• A Lessee benefits from the lower tax base: the leasing payments are fully accounted as production costs. The amount of depreciation is defined by the terms of a leasing agreement.
• Depreciation of the leasing object is calculated basing on its initial cost according to the schedule of the leasing payments; the calculation of depreciation is started as soon as a Lessee receives a vehicle and starts to use it. Thus, the vehicle being operated creates depreciation fund and pays itself off.
• The possibility of free depreciation allows the fastest renewal of the fleet.
• A whole leasing payment is fully accounted to the production cost, not just the vehicle cost (with only exception of the residual value, which is paid from the company’s profit, however usually it is equal to 0).
• At the end of a leasing contract, the accelerated depreciation allows a Lessee to have the fully depreciated property on balance.
• Actually, the installment of payments provides the possibility to invest freed working capital in the company development.
• The leasing payment schedule is arranged in a flexible and negotiable way. It allows a Lessee to customize the future payments with respect to the actual revenues. The leasing payments actually are the Lessee's expenses, which are taken into account for tax calculation in the correspondent time period. When arranging the leasing payment schedule, a Lessee can adjust the leasing payments to actual requirements.
• The period of a leasing contract validity can exceed the usual period of a bank credit.
• The subject of a leasing deal can’t be arrested because of financial problems, as it actually is the property of a Lessor.
• There is no need for additional security deposit, which is obligatory in case of financing.
• The procedure of applying for leasing is simplified in comparison with a bank credit.
• The possibility of gradual payments of VAT within periodical leasing payments and the possibility of VAT offset as opposed to crediting.

The stages of a leasing deal

Leasing: facts and history

The theory of leasing dates back to the time of Aristotle. One of his works is called “Wealth is in the right of use, not in the right of ownership”.

The first agreements on leasing were found in the Sumerian city of Ur in the form of clay tablets. The tablets contained the duties of transferring the rights of using agricultural tools, water pools, etc. for a definite period of time at a definite price. These findings date back as far as 2000 BC.

As for the leasing operations fully similar to the modern ones, they were put into practice with regard to farm equipment and horses in the medieval England.

The appearance of the term “leasing” dates back to the XIX century, when in 1877 the American telephone company “Bell” announced its decision to rent the produced apparatuses as the only option of ownership.

Later, at the end of the 1930s, Henry Ford was selling cars by using the scheme of the payments with deferred final settlements. Thus, each payment made up the capital value as well as the part of a vehicle cost. Meanwhile, in the 1940s, a car dealer from Chicago, Zoli Frank, instead of car rent offered a long-term leasing of all the vehicles in the fleet.

After World War II almost all the advanced countries started to implement accelerated wear and tear of the leasing objects to create additional incentives for the postwar growth. In 1952 the first leasing company "United States Leasing Corp." was set up in the USA. In France the first leasing company appeared in 1957.

Leasing terminology

Advance payment – the first leasing payment paid by a Lessee in the moment a leasing contract is signed.

Buy-out value – the cost of the leased unit after the full settlement of the periodic leasing payments, agreed by a Lessor and Lessee. It may be any amount, even zero.

Contract value of a unit for lease or capital cost – the cost of the leased unit, agreed by a Lessor and a Lessee in order to calculate the leasing payments.

Depreciation – accumulated wear of the fixed assets, expressed in monetary terms. Accelerated depreciation – the transfer of cost of the fixed assets to the expenses over a smaller time period than the real operation period.

Effective annual rate – the ratio of amount paid for a leasing contract in total to the capital cost of leasing property.

Financial leasing – a leasing type, according to which the leasing payments compensate no less than 75% of the capital cost of a leased unit, regardless whether the leased unit is bought out or returned.

Leaseback – a type of leasing deal, implying that Lessee sells its property to a Lessor, who then rents it back to Lessee. Such a deal is made to immediately receive working capital or to change the structure of the assets.

Leasing – a type of investing activity, implying that some property is acquired and then transferred to the third parties at the definite price and for a definite time period, set by a leasing agreement.

Leasing broker – a broker company, which specializes in the market of leasing services. It has the established contacts with leasing companies and vehicle dealers to offer the optimized and accelerated interaction between the participants of a leasing deal.

Leasing contract price – the total cost of all the leasing payments as well as the buy-out value of a leasing object.

Leasing contract – an agreement between Lessor and Lessee establishing the rights and obligations during the process of the Lessor's acquisition of a unit chosen be Lessee and further renting to Lessee for a fee.

Leasing cost – the total amount exceeding capital cost of the leased object, paid for the whole period of a leasing contract.

Leasing fee – the payment for the Lessor's works and services set by the contract.

Leasing object – any movable or immovable property, which can be transferred for lease with respect to legislation.

Leasing payment schedule – terms of payment of the periodical leasing fees. It contains the dates and amounts of the leasing payments to be made.

Leasing period – the period calculated from the moment when the Lessor's transfers a leasing object to a Lessee. The procedure, terms and conditions of making the leasing payments are defined with regard to a leasing contract.

Lessee – a company or an individual receiving an object of leasing for temporary use under the terms of a leasing contract.

Lessor – a company, which transfers to Lessee a specially acquired unit for lease accordingly to the relevant leasing agreement.

Leveraged lease – a leasing type, which presupposes only certain functions in relation to maintenance of the property.

Operating leasing - a type of leasing, according to which the leasing payments compensate a Lessor up to 75% of the leased unit's contract value; when the leasing period ends Lessee returns the leased object to a Lessor.

Residual value – the difference between the contract value of a leased object and the amount of depreciation (calculated over the period of a leasing agreement).

Revolving leasing – a type of leasing implying that a leasing agreement is prolonged for the next period upon the expiration. Meanwhile, the leasing objects are replaced for the better ones.

Seller – an individual or legal body, who sells the chosen for lease property to a Lessor.

Subleasing – a leasing type, which allows a Lessee to transfer a leasing object to other Lessees for further operation, upon the permission of a Lessor.

Wet leasing – a type of leasing, according to which a Lessor provides raw materials and specialist training to operate the corresponding machinery together with technical maintenance of machinery.

Leasing: FAQ

What is accelerated wear and tear?

This is the depreciation of a leased object during its exploitation, which is reflected in the accounting reports. It is "accelerated" because its amount is defined by a leasing contract agreed by a leaser and a leaseholder, making it possible to depreciate this object by 100% to the end of the leasing period.

What are the main conditions of a leasing contract?

These are:

• leasing object: its designation, quantitative and other characteristics, which make it possible to specifically define the property to be transferred under leasing contract;
• a reference to the party making choice of a leasing subject and its seller;
• the contract value of a leasing subject;
• an amount of leasing payments or the terms of defining this amount; way to pay these payments and deadlines according to the conditions of leasing agreement;
• a leasing contract price or the terms of defining it;
• the provision of a leasing period.

Briefly: why is leasing better than a bank credit?

• there is no need for additional security deposit, the leasing object is the Lessor's property;
• the income tax is reduced as leasing payments are accounted as production costs;
• VAT may be offset according to the leasing payment schedule;
• a leasing object can’t be put under arrest by the tax authority and transferred to the third parties to cover Lessees' debts;
• a leasing object cannot be revaluated during the leasing period.

Is it possible to lease used machinery?

Yes, it is. However, every leasing company has its own special restrictions on the cost and terms.

What is the minimal duration of the leasing contract period?

Generally, the minimal leasing contract period is 1 year.

What is effective leasing rate?

To make commercial deals clear and transparent, leasing companies use such a term as effective rate. This number indicates, how much the property on lease will rise in price over a year, in other words how much you will overpay. Effective leasing rate reflects all the leaseholder’s overpayments. That is to say, if a leasing company adds extra expenses to the commercial offer, the effective rate will rise correspondingly. This number depends on various parameters, such as the amount of advance payment, a leasing period, the amounts of a leasing fees, the way of compensating the cost in leasing payment schedule.

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