A Reference Guide to Trade Finance TechniquesLeasing
Leasing is a technique which allows a
company to have access to a particular
asset, while paying for it over an extended
period (rather than up front). The precise
accounting treatment, including whether the
asset is recorded in full on the balance sheet
along with a notional financing loan, depends
on the way the prevailing local accounting
rules view the terms of the lease agreement
(i.e. whether the agreement is considered a
finance lease or an operating lease). From a
working capital perspective, this means cash
is available for other purposes.
How it works
All leases allow the borrower (lessee) to
use a particular asset, which is owned by a
specialist finance company (lessor) for the
term of the lease.
There are essentially two types of leases,
finance leases and operating leases, which
have slight differences between them.
Generally speaking, an asset used on an
operating lease will have a significant residual
value at the end of the term. This allows the
lessor to sell the asset to the borrower or a
third party at the end of the term. On the other
hand, a finance lease tends to be structured
in such a way that the lessor recoups its
investment in the asset over the term of the
lease, at the end of which the asset has very
little residual value. These differences result
in the borrower assuming different risks
depending on the type of lease used.
Under the terms of a finance lease,
the borrower is usually responsible for
maintenance of the asset under the
agreement. As a result, the borrower
assumes most of the risk associated with
the transaction. Under an operating lease,
the finance company can be responsible
for maintenance. Because the contract will
be structured such that the asset has a
significant residual value at term, the finance
company needs to be able to realise that
value, whether by selling the asset to the
borrower or a third party. Consequently the
finance company is assuming much of the
risk associated with the contract under the
terms of an operating lease.
The precise distinction between finance
and operating leases is determined by the
local accounting rules. Under International
Financial Reporting Standards (IAS17), a
finance lease is a lease contract which fulfils
one or more of the following conditions.
The borrower takes ownership of the asset
at the end of the term.
The borrower has the option of buying the
asset for below its fair market value.
The term of the lease represents almost
all the economic life of the asset.
The net present value of future payments
by the borrower at the beginning of the
lease under the terms of the lease is equal
or close to the fair value of the asset.
The asset cannot be used by another
borrower unless major changes are made
to the asset.
A finance lease will have a larger impact on a
company’s balance sheet than an operating
lease, reflecting the fact that the borrower is
assuming most of the risk of the transaction.
The effect of a finance lease is to increase
both assets and liabilities on the balance
sheet. There will also be an impact on the
cash flow statement, with both the interest
charge and the asset value being recognised.
However, proposals first issued by the
International Accounting Standards Board
in 2009 will change the distinction between
finance leases and operating leases. These
proposals will mean that operating leases
will also be capitalised on the balance sheet
of the lessee along with the recognition of a
corresponding liability. A second exposure
draft is due to be released in 2013. In this
draft, the accounting treatment is expected
to be determined by the extent to which the
lessee consumes the asset. For example, a
property lease (where the asset value does
not change significantly over the lease term)
should be accounted for differently than an
equipment lease (which may have a low
residual value).
Leasing can be used to facilitate trade.
The further element for the borrower is
to establish whether to lease from a local
finance company or on a cross-border basis.