What is lease leverage in special financing?

Leverage lease is an agreement between lessor and lender. This agreement tell that lessor purchases the asset from the lender by acquiring funds from third part or from taking loan from financial institutions.

In this, the lessor transfers lease rents to financial institution or to the third party. The financial institutions or third party charges loan instalments and balance amount (if any) will be transferred to lessor.

Characteristics of leverage ratio are mentioned below −

• Transfer ownership to the lessor at the end of lease.
• Lessee can buy the asset below fair value.
• Lease terms is for about 3/4th of asset economic life.
• Minimum lease payments will be more than 90% of present value of asset fair value.
• Additional cost is not reimbursable.
• Should involve all three parties (a lessor, a lessee and a lender).
• Largely financed by lender.
• Net investment of the lessor will decline during initial periods and gradually rises in later periods.
• Loan financed on non - resource basis.

Accounting treatment

It is divided into three parts as follows −

• Pre-tax income of the year.
• Tax credit and its amortisation.
• Post tax income of the year.

Difference between leverage finance and leverage lease is mentioned below −

• In leverage lease, three parties are involved which are a lessor, a lessee and the lender. Whereas in leverage finance, only two parties are involved which are a lessor and a lessee.

• In leverage lease, payment lies are between the lessee and the lender. Whereas in leverage finance, payments lies are between the lessee and the lessor.

• In the lease finance, lender have right on the asset. Whereas in leverage finance, lessor have right on the asset,

• Leverage financing is simple to understand. Whereas, lease leverage is a bit complicated to understand.

Difference between leverage lease and operating lease is explained below −

• In leverage lease, the risk and obligations are with lessee. Whereas in operating lease, the risk and obligations are with lessor.

• In leverage lease, three parties are involved a lessor, a lessee and the lender. Whereas in operating lease, only two parties are involved a lessor and a lessee.

• In leverage lease, agreement can be cancelled. Whereas in operating lease, agreement can be cancelled.

• In leverage lease, funds are arranged by lessor and the lender (third party or by some financial institutions). In operating lease, total funds are arranged by lessor only.

• In leverage lease, payments can be shown as leased assets in balance sheet. Whereas in operating lease, payments can’t be shown in balance sheet.