Assets are defined as anything of monetary value that is owned by a firm or an individual. Assets listed on a firm’s balance sheet can include tangible items such as inventories, equipment and real estate, as well as intangible items such as property rights or goodwill.
Leases differ from term lending in that the lessee does not have ownership rights to the asset. At the end of the lease contract, the lessee usually has a choice of extending the lease, returning the asset, or introducing a buyer for the asset. Some leasers are entitled to a refund of 95% of the sale proceeds when they introduce a buyer. The refund amount will depend on the contract between the original leaser and lessee.
HP is a financing solution suitable for businesses wishing to purchase assets without paying the full value immediately. The customer pays an initial deposit, with the remainder of the balance and interest paid over a period of time. On completion, ownership of the asset transfers to the customer.
It is important to note that the accounting and tax treatment of leases varies according to the type of lease it is. For example, as a finance lease is accounted for as a loan funding the asset, the tax treatment follows the legal form of the transaction which is the hiring of an asset. More specifically, the treatment of capital allowances differs, and tax treatment should be taken into consideration when deciding how to finance an asset purchase.
The use of HP or leasing is particularly common in industries where expensive machinery is required, such as construction, manufacturing, plant hire, printing, road freight, transport, engineering and professional services.
It is also used to finance other capital requirements of a business, for example:
- Smaller items
The asset provider usually dictates this type of linked finance.
There are two main costs that need to be considered:
- Interest rate charged for financing. Rates are favourable to assets with higher resale value (ie machinery, agricultural equipment, vehicles etc). Assets that are considered ‘soft’ due to their low resale value (ie printers, vending machines, office furniture etc), will be given less favourable rates
- Fees charged by the financing company for loan processing and administrative work meeting conditions. For example, a car purchased on HP may need servicing at regular intervals and from a pre-approved workshop.
An HP or leasing facility can normally take up to a week to complete, depending on the size and complexity of the deal.
- HP or leasing allows companies to control and deploy assets without significant drain on working capital
- Fixed-rate funding makes budgeting easy as the lessee has clear sight of future expenditures
- Flexibility of repayment structuring is available to allow for seasonal business (eg one repayment a year), and to reduce monthly outlay by factoring in a ‘balloon’ payment at the end of the term
- Leasing prevents the risk of an asset’s value depreciating quickly and provides flexibility to enter into a new contract at the end of the original lease’s fixed term
- Financing asset purchases can be more tax efficient than standard-term loans due to lease payments being booked as expenses. Although asset depreciation also provides tax benefits, the useable lifetime of the asset will vary depending on the asset and on local regulation
- High accessibility of financing for businesses due to the financing being secured with the leased asset and the asset being owned by the financing company
- In certain circumstances there is maintenance included within the terms of the agreement.
- Total sum of capital payments for HP or leasing will be higher than the full payment on the asset purchase
- Administrative complexity and costs will be greater if any covenants are applied to the arrangement – for example, updates on change of equipment locations
- If the business changes its strategy, resulting in the leased asset no longer being useful, there can be early termination charges or restrictions on subleasing.
Features and characteristics of hire purchase
Hire purchase is a typical transaction in which the assets are allowed to be hired and the hirer is provided an option to later purchase the same assets.
Following are the features of a regular hire purchase transaction:
- Rental payments are paid in installments over the period of the agreement.
- Each rental payment is considered as a charge for hiring the asset. This means that, if the hirer defaults on any payment, the seller has all the rights to take back the assets.
- All the required terms and conditions between both the parties involved are documented in a contract called Hire-Purchase agreement.
- The frequency of the installments may be annual, half-yearly, quarterly, monthly, etc. according to the terms of the agreement.
- Assets are instantly delivered to the hirer as soon as the agreement is signed.
- If the hirer uses the option to purchase, the assets are passed to him after the last installment is paid.
- If the hirer does not want to own the asset, he can return the assets any time and is not required to pay any installment that falls due after the return.
- However, once the hirer returns the assets, he cannot claim back any payments already paid as they are the charges towards the hire and use of the assets.
- The hirer cannot pledge, sell or mortgage the assets as he is not the owner of the assets till the last payment is made.
- The hirer, usually, pays a certain amount as an initial deposit / down payment while signing the agreement.
- Generally, the hirer can terminate the hire purchase agreement any time before the ownership rights pass to him.