Joint Ventures
INTRODUCTION
Where a businessman finds it difficult to undertake any business work or a venture alone, he /she may associate with other businessman/ businesswoman. Such an association of persons is for a short period or for a particular venture and is known as ‘Joint Venture’. It is regarded as a temporary partnership without a firm name and it ceases with the completion of the task undertaken. Persons, who have come together, are called co-venturers and not partners. The co-venturers enter into a contract with each other, deciding about their capital contribution and share of profit. In the absence of any agreement, profit and losses are shared equally by the co-venturers.
DEFINITION
A dictionary for accountants, by Eric L. Kohler, defines joint venture as under:
‘A commercial undertaking by two or more persons, differing from a partnership in that relate to disposition of a single lot of goods or the completion of a single project. Its duration is limited to the period in which goods are sold or the project is carried on.’
FEATURES
The essential features of a joint venture agreement are: (1) It is an agreement between two or more persons. (2) The agreement is made to carry on a specific job.
(3) The agreement is over as soon as the venture is completed.
(4) It is a temporary partnership without any firm’s name.
DISTINCTION BETWEEN JOINT VENTURE AND PARTNERSHIP
(1) A partnership has a firm name while a joint venture does not possess such a common name. (2) A partnership is a continuing business whereas a joint venture is purely temporary in nature.
(3) The persons who enter into joint venture are called co-venturers while in case of a partnership,
such persons are called partners.
(4) Partners have joint and several liabilities while in a joint venture it depends on the mode of contract.
(5) Separate set of books is maintained in case of a partnership firm whereas the same is not a must in case of a joint venture.
(6) In a partnership firm, accrual basis of accounting is followed whereas in a joint venture cash basis of accounting is usually followed.
(7) In a partnership, profit or loss is ascertained at the end of the year whereas in a joint venture it is ascertained on completion of each venture.
DISTINCTION BETWEEN JOINT VENTURE AND CONSIGNMENT
(1) In a joint venture, the venturers contribute capital and share the profit or losses according to an agreed ratio, whereas, in a consignment, the consignee does not contribute any capital and he is not entitled to the profit or loss but he gets a commission at an agreed rate.
(2) In a joint venture, each co-venturer can take part in the management of the venture, whereas in consignment, neither the consignor nor the consignee can take part in the other’s business.
(3) A joint venture is governed by the Partnership Act and by the terms of contract between the co- venturers but a consignment is governed by the law relating to ‘Agency’ and the terms of contract between parties to the contract.
(4) A joint venture may be regarded as a temporary partnership whereas consignment is not similar to joint venture since the relationship between consignor and consignee is that of the ‘Principal’ and
‘Agent’
Consignment Account
MEANING
A consignment is the dispatch of goods by its owner to his agent for the purpose of selling. The former is called the ‘Principal’ or ‘Consignor’ and the latter is called ‘Agent’ or ‘Consignee’. The goods so dispatched or sent by the consignor is regarded as ‘Consignment Outward’ in the books of consignor, whereas the goods so received by the consignee is treated as ‘Consignment Inward’ in his books.
DIFFERENCE BETWEEN CONSIGNMENT AND SALE
The following points may be noted.
(a) According to Sale of Goods Act, where the property in the goods is transferred from the seller to the buyer, the contract is called a ‘sale’. But in consignment, the ownership of the goods is not transferred to the consignee.
(b) In actual sale, the purchaser can dispose off the goods according to his own choice and desire since he is the owner of such goods. But in a consignment, the consignee cannot do so since he is not the owner of the goods and at the same time, he is bound to sell the same prescribed by the consignor.
(c) In case of sale, risk is transferred from the seller to the buyer as soon as the transaction takes place. Therefore, any loss, if incurred, is to be borne by the purchaser. But in case of consignment, loss is to be borne by the consignor and not by the consignee since he is only the agent.
(d) In a contract of sale, the purchaser cannot return the goods to the seller, but in consignment, the consignee can do so if he thinks that the goods are not marketable.
PROFORMA INVOICE
It is an invoice sent by consignor to the consignee stating full details of the goods consigned, such as quantity, grade, value, etc. Since transfer of goods to consignee is not a sale, the invoice is called ‘Pro forma Invoice’.
ACCOUNT SALE
Consignor, who is a manufacturer or wholesaler, sends the consignment to his agent, consignee, for selling the goods on his behalf at the best available price. The consignor, reimburses all legitimate expenses incurred by the consignee for selling these goods. Such expenses include rental of shop, salary and commission to salesmen, etc. The consignee is given a fixed rate of commission over and above the reimbursement of expenses. The consignee is required to submit to the consignor a statement, showing details of goods sold, expenses incurred, commission due to him and how the balance payable to consignor is settled. This statement is called ‘Account Sale’
VALUATION OF CLOSING STOCK
Unsold stock of goods with the consignee must be valued properly. The stock is valued at cost plus the proportionate expenses incurred by the consignor and the consignee. In case of the consignor, all expenses incurred for sending goods to the consignee are to be considered. But in case of consignee, only non- recurring or direct expenses, incurred by him are taken into account.
CONSIGNING GOODS AT A HIGHER PRICE
When the consignor thinks that the consignee should have no knowledge of the cost of goods consigned, he prepares a pro forma invoice at a higher price. Another object of preparing the pro forma invoice at a higher price is to keep the consignee in the dark about the actual amount of profit earned. The excess amount, over the cost price, is called ‘Loading’. When goods are consigned at the ‘Invoice Price’ (Loaded Price), the consignment account is debited with the loaded price and immediately the excess over the cost is credited to consignment account so that the element of the unrealized profit is removed. Similarly, while valuing closing stocks, goods are valued first at the invoice price and the excess included in the stocks is transferred to consignment stock revenue by debiting consignment account.
COMMISSION PAYABLE TO CONSIGNEE
Over and above the reimbursement of expenses incurred by the consignee, he is paid a commission at a fixed rate on the sales by him. Commission payable to the consignee is of two types, i.e.
(1) Ordinary and
(2) Del Credere.
Ordinary commission is paid at a fixed rate on all sales made by him, cash as well as credit. Collection charges, loss due to bad debts must be borne by the consignor.
Del Credere commission is an extra commission, over and above the normal, paid to the consignee for selling goods on credit. Under these circumstances, all losses due to bad debts, collection charges and discount must be borne by the consignee. This is calculated on total sales.
NORMAL LOSS
If some loss is unavoidable (e.g, leakage) it would be spread over the entire consignment while valuing stock. The total cost plus expenses incurred should be divided by the quantity available after the normal loss to ascertain the cost per unit.
ABNORMAL LOSS
If any accidental or unnecessary loss occurs then such loss is ascertained and transferred to the profit and loss account.
LEASING
Definition
Leasing can be described as a contract between two parties, whereby the owner of an asset transfers his right of use to some other party on payment of a fixed periodical rent.
Essential features of a lease contract
There are two parties to a lease transaction, the owner of the asset known as the lessor and the user of the asset as the lessee. By virtue of the lease agreement, the lessee gets the right of uninterrupted use of the asset provided he makes the payment of lease rentals regularly. During the entire period of currency of the contract, the ownership of the asset remains with the lessor only. The contract is usually for a specific period, normally five years and on the expiry of the same, it can be renewed or terminated or the asset can be purchased by the lessee depending upon the terms of the contract.
Advantages
Leasing, as a means of organising industrial production capacity, has become very popular in India in the last few years. The leasing is beneficial both to the lessor as well as the lessee.
Advantages to Lessor
1. Expansion of business: Manufacturers of plant and machinery with high prices may find it difficult to expand their sales if they insist on selling their products on an outright ownership basis. Owing to recession in the economy, the growth of capital goods industry is affected to a considerable extent. In this situation, leasing is increasingly used to revive the demand for capital goods. The manufacturers of the capital goods have benefited immensely by adopting leasing arrangements.
2. Tool of tax planning: If a manufacturer or a dealer sells capital goods, it increases his profits and as a result, he will pay more income tax. Larger the sales, higher is the profit and consequently higher the tax liability. Instead of selling the capital goods, if the manufacturer or dealer leases them out, the lease rent becomes receivable over a long period. Thus, with the help of leasing, manufacturer or a dealer or lessor reduces his tax liability. In this way, leasing can be used as
a tax-planning tool.
Advantages to Lessee
1. Reduction in capital investment: Instead of purchasing the capital goods, if the same are taken on lease, the manufacturer can reduce the capital investment in the project. Entrepreneurs with lower financial capacity can start a venture without investing huge funds. Leasing also saves the interest
burden on funds which the lessee would have paid on the borrowed fund for purchasing the assets.
2. Elimination of risk of obsolescence: With fast developing technology, the owner of an asset has to bear the risk of his asset becoming obsolete or outdated. Since the lessee is not the owner of the asset, he does not have to bear this risk. If the lease period is short, on expiry of the lease period, the lessee can take on lease another capital asset having the most advanced technology.
3. Increase in borrowing capacity: If the capital goods are purchased with borrowed funds, the asset, as well as the borrowed funds, appear in the balance sheet; this reduces further borrowing capacity of the business – although leasing of capital assets involves substantial payments over a long period. In future, such liability need not be shown in the balance sheet. From the point of view of the lenders of the long-term loans, the borrower’s borrowing capacity increases with no past borrowings. Thus, the lessee can borrow more funds from the financial institutions without much difficulty.
4. Reduction in tax liability: Lease rent payable by the lessee is treated as revenue expenditure in his hand which is fully debited to profit and loss account before calculating the taxable profit of the lessee. This will reduce his tax liability.
5. Application of certain laws: The provisions of the Monopolies and Restrictive Trade Practices
Act can be avoided by keeping the capital investment at a lower level.
6. Interference of financial institutions: Leasing reduces the dependence on the financial institutions and banks for borrowing huge sums for long-term or medium term. Thus, the lessee can avoid interference of these institutions in the day-to-day management of his organisation.
Limitations
1. Lease rent may be quite burdensome to the lessee as it has to cover the cost of depreciation, cost of finance and administrative expenses of the lessor.
2. When the lessor has acquired the leased assets by borrowing funds against the hypothecation of the leased assets, any default on the part of the lessor may adversely affect the operations of the lessee.
3. Leasing only shifts the need for borrowing from the lessee to the lessor. Thus, for the banks and the financial institutions, the demand for the finance remains the same.
4. Leased assets are not eligible for capital subsidies available for projects in backward areas.
5. Generally, lease rental structures do not provide for a moratorium period as available in respect of finance from banks/financial institutions. Thus, leasing is considered unattractive for projects with a long gestation period.
6. The disadvantage to the lessee in cases of financial lease is that he is not entitled to the protection of warranties from the supplier of the equipments as the same are purchased by lessor. He has to pay lease rentals in spite of loss, destruction or defects in the leased assets.
Types of Leases
Lease is mainly of four types:
1. Finance or Capital lease
2. Operating lease
3. Service lease
4. Leveraged lease
1. Finance or Capital Lease
This is the most popular type of lease. It is fairly long-term in nature. Generally, the entire economic life of the asset is agreed to be transferred for use by the lessee, though the ownership remains with the lessor. Lessee agrees to pay the fixed instalments (lease rentals) which, in total, exceed the cost of equipment. Normally, such a contract is non-cancellable in nature during the primary period. Lessee bears the risk of obsolescence and under utilisation, if any. The lease is generally spread into two periods:
(a) Primary Period: Normally, for equipment, the period is five years. The lessor recovers the cost of the asset and interest thereon during this period.
(b) Secondary Period: It starts after the primary period is over. The lease is continued on a very nominal rental.
2. Operating Lease
Operating lease is a lease which is not ‘Finance’ or a ‘Capital’ lease. It does not transfer any of the rewards and risks of ownership of the leased property to the lessee. The contract is, usually, cancellable and of lower maturity period than in the case of financial lease. Normally, the period of lease is much less compared to the economic life of the asset. Leasing of telephones, vehicles, computers, etc., are some of the examples of operating lease. The lease period is normally for a short period and may stretch from a day to about three years.
3. Service Lease
It is a lease agreement effected by manufacturers or dealers of capital goods (like machinery) or consumer durables (like Air-conditioners, etc.) in which they deal. Service lease covers the cost of maintenance and servicing the assets for a short period. The lease payment covers cost of servicing and not the capital outlay. Sometimes, the lessee may be given an option to retain the asset on the expiry of the lease period.
4. Leveraged Lease
In this type of lease, there are three parties to the lease agreement. In addition to the lessor and the lessee, the third party is the financier to lessor. Hence, the lease is also known as a ‘Third Party Lease’. Under this lease, the third party provides the finance to the lessor. Leasing has nowadays become a specialised service industry. Many leasing companies have been formed to purchase assets and give them on lease to the lessees. The leasing companies give plant and machinery, factory buildings, worth crore of rupees, on lease. In order to lease such assets involving huge capital outlays, even leasing companies have to borrow huge funds. When a business uses borrowed funds, having low costs, to maximise its profits, it is said in the financial management that the business has used financial leverage. Since the leasing companies (i.e. the lessors) use borrowed funds to finance their leasing activities, such lease is known as ‘Leveraged Lease’.
HIRE PURCHASE AND INSTALMENT SALE
Meaning
In a hire purchase and in instalment sale, a buyer purchases goods but pays the price of the goods not in one lump sum but in various instalments. The buyer takes possession of the goods and enjoys them as if he is the sole owner of the goods, although, the price for the goods is not fully paid.
The person who purchases goods on hire purchase basis is called ‘hirer’; while the seller is called ‘hire purchase seller ’, ‘hire purchase vendor’ or ‘owner’. The hire purchase agreement must be in writing. It includes the description of the goods, cash price, interest to be charged, number of instalments and so on. The hire purchase price consists of two elements:
(1) Cash price and
(2) Interest for delayed payments.
Normally, a certain amount is paid immediately at the time of signing the agreement. This is called
‘Down’ payment.
INTRODUCTION
Where a businessman finds it difficult to undertake any business work or a venture alone, he /she may associate with other businessman/ businesswoman. Such an association of persons is for a short period or for a particular venture and is known as ‘Joint Venture’. It is regarded as a temporary partnership without a firm name and it ceases with the completion of the task undertaken. Persons, who have come together, are called co-venturers and not partners. The co-venturers enter into a contract with each other, deciding about their capital contribution and share of profit. In the absence of any agreement, profit and losses are shared equally by the co-venturers.
DEFINITION
A dictionary for accountants, by Eric L. Kohler, defines joint venture as under:
‘A commercial undertaking by two or more persons, differing from a partnership in that relate to disposition of a single lot of goods or the completion of a single project. Its duration is limited to the period in which goods are sold or the project is carried on.’
FEATURES
The essential features of a joint venture agreement are: (1) It is an agreement between two or more persons. (2) The agreement is made to carry on a specific job.
(3) The agreement is over as soon as the venture is completed.
(4) It is a temporary partnership without any firm’s name.
DISTINCTION BETWEEN JOINT VENTURE AND PARTNERSHIP
(1) A partnership has a firm name while a joint venture does not possess such a common name. (2) A partnership is a continuing business whereas a joint venture is purely temporary in nature.
(3) The persons who enter into joint venture are called co-venturers while in case of a partnership,
such persons are called partners.
(4) Partners have joint and several liabilities while in a joint venture it depends on the mode of contract.
(5) Separate set of books is maintained in case of a partnership firm whereas the same is not a must in case of a joint venture.
(6) In a partnership firm, accrual basis of accounting is followed whereas in a joint venture cash basis of accounting is usually followed.
(7) In a partnership, profit or loss is ascertained at the end of the year whereas in a joint venture it is ascertained on completion of each venture.
DISTINCTION BETWEEN JOINT VENTURE AND CONSIGNMENT
(1) In a joint venture, the venturers contribute capital and share the profit or losses according to an agreed ratio, whereas, in a consignment, the consignee does not contribute any capital and he is not entitled to the profit or loss but he gets a commission at an agreed rate.
(2) In a joint venture, each co-venturer can take part in the management of the venture, whereas in consignment, neither the consignor nor the consignee can take part in the other’s business.
(3) A joint venture is governed by the Partnership Act and by the terms of contract between the co- venturers but a consignment is governed by the law relating to ‘Agency’ and the terms of contract between parties to the contract.
(4) A joint venture may be regarded as a temporary partnership whereas consignment is not similar to joint venture since the relationship between consignor and consignee is that of the ‘Principal’ and
‘Agent’
Consignment Account
MEANING
A consignment is the dispatch of goods by its owner to his agent for the purpose of selling. The former is called the ‘Principal’ or ‘Consignor’ and the latter is called ‘Agent’ or ‘Consignee’. The goods so dispatched or sent by the consignor is regarded as ‘Consignment Outward’ in the books of consignor, whereas the goods so received by the consignee is treated as ‘Consignment Inward’ in his books.
DIFFERENCE BETWEEN CONSIGNMENT AND SALE
The following points may be noted.
(a) According to Sale of Goods Act, where the property in the goods is transferred from the seller to the buyer, the contract is called a ‘sale’. But in consignment, the ownership of the goods is not transferred to the consignee.
(b) In actual sale, the purchaser can dispose off the goods according to his own choice and desire since he is the owner of such goods. But in a consignment, the consignee cannot do so since he is not the owner of the goods and at the same time, he is bound to sell the same prescribed by the consignor.
(c) In case of sale, risk is transferred from the seller to the buyer as soon as the transaction takes place. Therefore, any loss, if incurred, is to be borne by the purchaser. But in case of consignment, loss is to be borne by the consignor and not by the consignee since he is only the agent.
(d) In a contract of sale, the purchaser cannot return the goods to the seller, but in consignment, the consignee can do so if he thinks that the goods are not marketable.
PROFORMA INVOICE
It is an invoice sent by consignor to the consignee stating full details of the goods consigned, such as quantity, grade, value, etc. Since transfer of goods to consignee is not a sale, the invoice is called ‘Pro forma Invoice’.
ACCOUNT SALE
Consignor, who is a manufacturer or wholesaler, sends the consignment to his agent, consignee, for selling the goods on his behalf at the best available price. The consignor, reimburses all legitimate expenses incurred by the consignee for selling these goods. Such expenses include rental of shop, salary and commission to salesmen, etc. The consignee is given a fixed rate of commission over and above the reimbursement of expenses. The consignee is required to submit to the consignor a statement, showing details of goods sold, expenses incurred, commission due to him and how the balance payable to consignor is settled. This statement is called ‘Account Sale’
VALUATION OF CLOSING STOCK
Unsold stock of goods with the consignee must be valued properly. The stock is valued at cost plus the proportionate expenses incurred by the consignor and the consignee. In case of the consignor, all expenses incurred for sending goods to the consignee are to be considered. But in case of consignee, only non- recurring or direct expenses, incurred by him are taken into account.
CONSIGNING GOODS AT A HIGHER PRICE
When the consignor thinks that the consignee should have no knowledge of the cost of goods consigned, he prepares a pro forma invoice at a higher price. Another object of preparing the pro forma invoice at a higher price is to keep the consignee in the dark about the actual amount of profit earned. The excess amount, over the cost price, is called ‘Loading’. When goods are consigned at the ‘Invoice Price’ (Loaded Price), the consignment account is debited with the loaded price and immediately the excess over the cost is credited to consignment account so that the element of the unrealized profit is removed. Similarly, while valuing closing stocks, goods are valued first at the invoice price and the excess included in the stocks is transferred to consignment stock revenue by debiting consignment account.
COMMISSION PAYABLE TO CONSIGNEE
Over and above the reimbursement of expenses incurred by the consignee, he is paid a commission at a fixed rate on the sales by him. Commission payable to the consignee is of two types, i.e.
(1) Ordinary and
(2) Del Credere.
Ordinary commission is paid at a fixed rate on all sales made by him, cash as well as credit. Collection charges, loss due to bad debts must be borne by the consignor.
Del Credere commission is an extra commission, over and above the normal, paid to the consignee for selling goods on credit. Under these circumstances, all losses due to bad debts, collection charges and discount must be borne by the consignee. This is calculated on total sales.
NORMAL LOSS
If some loss is unavoidable (e.g, leakage) it would be spread over the entire consignment while valuing stock. The total cost plus expenses incurred should be divided by the quantity available after the normal loss to ascertain the cost per unit.
ABNORMAL LOSS
If any accidental or unnecessary loss occurs then such loss is ascertained and transferred to the profit and loss account.
LEASING
Definition
Leasing can be described as a contract between two parties, whereby the owner of an asset transfers his right of use to some other party on payment of a fixed periodical rent.
Essential features of a lease contract
There are two parties to a lease transaction, the owner of the asset known as the lessor and the user of the asset as the lessee. By virtue of the lease agreement, the lessee gets the right of uninterrupted use of the asset provided he makes the payment of lease rentals regularly. During the entire period of currency of the contract, the ownership of the asset remains with the lessor only. The contract is usually for a specific period, normally five years and on the expiry of the same, it can be renewed or terminated or the asset can be purchased by the lessee depending upon the terms of the contract.
Advantages
Leasing, as a means of organising industrial production capacity, has become very popular in India in the last few years. The leasing is beneficial both to the lessor as well as the lessee.
Advantages to Lessor
1. Expansion of business: Manufacturers of plant and machinery with high prices may find it difficult to expand their sales if they insist on selling their products on an outright ownership basis. Owing to recession in the economy, the growth of capital goods industry is affected to a considerable extent. In this situation, leasing is increasingly used to revive the demand for capital goods. The manufacturers of the capital goods have benefited immensely by adopting leasing arrangements.
2. Tool of tax planning: If a manufacturer or a dealer sells capital goods, it increases his profits and as a result, he will pay more income tax. Larger the sales, higher is the profit and consequently higher the tax liability. Instead of selling the capital goods, if the manufacturer or dealer leases them out, the lease rent becomes receivable over a long period. Thus, with the help of leasing, manufacturer or a dealer or lessor reduces his tax liability. In this way, leasing can be used as
a tax-planning tool.
Advantages to Lessee
1. Reduction in capital investment: Instead of purchasing the capital goods, if the same are taken on lease, the manufacturer can reduce the capital investment in the project. Entrepreneurs with lower financial capacity can start a venture without investing huge funds. Leasing also saves the interest
burden on funds which the lessee would have paid on the borrowed fund for purchasing the assets.
2. Elimination of risk of obsolescence: With fast developing technology, the owner of an asset has to bear the risk of his asset becoming obsolete or outdated. Since the lessee is not the owner of the asset, he does not have to bear this risk. If the lease period is short, on expiry of the lease period, the lessee can take on lease another capital asset having the most advanced technology.
3. Increase in borrowing capacity: If the capital goods are purchased with borrowed funds, the asset, as well as the borrowed funds, appear in the balance sheet; this reduces further borrowing capacity of the business – although leasing of capital assets involves substantial payments over a long period. In future, such liability need not be shown in the balance sheet. From the point of view of the lenders of the long-term loans, the borrower’s borrowing capacity increases with no past borrowings. Thus, the lessee can borrow more funds from the financial institutions without much difficulty.
4. Reduction in tax liability: Lease rent payable by the lessee is treated as revenue expenditure in his hand which is fully debited to profit and loss account before calculating the taxable profit of the lessee. This will reduce his tax liability.
5. Application of certain laws: The provisions of the Monopolies and Restrictive Trade Practices
Act can be avoided by keeping the capital investment at a lower level.
6. Interference of financial institutions: Leasing reduces the dependence on the financial institutions and banks for borrowing huge sums for long-term or medium term. Thus, the lessee can avoid interference of these institutions in the day-to-day management of his organisation.
Limitations
1. Lease rent may be quite burdensome to the lessee as it has to cover the cost of depreciation, cost of finance and administrative expenses of the lessor.
2. When the lessor has acquired the leased assets by borrowing funds against the hypothecation of the leased assets, any default on the part of the lessor may adversely affect the operations of the lessee.
3. Leasing only shifts the need for borrowing from the lessee to the lessor. Thus, for the banks and the financial institutions, the demand for the finance remains the same.
4. Leased assets are not eligible for capital subsidies available for projects in backward areas.
5. Generally, lease rental structures do not provide for a moratorium period as available in respect of finance from banks/financial institutions. Thus, leasing is considered unattractive for projects with a long gestation period.
6. The disadvantage to the lessee in cases of financial lease is that he is not entitled to the protection of warranties from the supplier of the equipments as the same are purchased by lessor. He has to pay lease rentals in spite of loss, destruction or defects in the leased assets.
Types of Leases
Lease is mainly of four types:
1. Finance or Capital lease
2. Operating lease
3. Service lease
4. Leveraged lease
1. Finance or Capital Lease
This is the most popular type of lease. It is fairly long-term in nature. Generally, the entire economic life of the asset is agreed to be transferred for use by the lessee, though the ownership remains with the lessor. Lessee agrees to pay the fixed instalments (lease rentals) which, in total, exceed the cost of equipment. Normally, such a contract is non-cancellable in nature during the primary period. Lessee bears the risk of obsolescence and under utilisation, if any. The lease is generally spread into two periods:
(a) Primary Period: Normally, for equipment, the period is five years. The lessor recovers the cost of the asset and interest thereon during this period.
(b) Secondary Period: It starts after the primary period is over. The lease is continued on a very nominal rental.
2. Operating Lease
Operating lease is a lease which is not ‘Finance’ or a ‘Capital’ lease. It does not transfer any of the rewards and risks of ownership of the leased property to the lessee. The contract is, usually, cancellable and of lower maturity period than in the case of financial lease. Normally, the period of lease is much less compared to the economic life of the asset. Leasing of telephones, vehicles, computers, etc., are some of the examples of operating lease. The lease period is normally for a short period and may stretch from a day to about three years.
3. Service Lease
It is a lease agreement effected by manufacturers or dealers of capital goods (like machinery) or consumer durables (like Air-conditioners, etc.) in which they deal. Service lease covers the cost of maintenance and servicing the assets for a short period. The lease payment covers cost of servicing and not the capital outlay. Sometimes, the lessee may be given an option to retain the asset on the expiry of the lease period.
4. Leveraged Lease
In this type of lease, there are three parties to the lease agreement. In addition to the lessor and the lessee, the third party is the financier to lessor. Hence, the lease is also known as a ‘Third Party Lease’. Under this lease, the third party provides the finance to the lessor. Leasing has nowadays become a specialised service industry. Many leasing companies have been formed to purchase assets and give them on lease to the lessees. The leasing companies give plant and machinery, factory buildings, worth crore of rupees, on lease. In order to lease such assets involving huge capital outlays, even leasing companies have to borrow huge funds. When a business uses borrowed funds, having low costs, to maximise its profits, it is said in the financial management that the business has used financial leverage. Since the leasing companies (i.e. the lessors) use borrowed funds to finance their leasing activities, such lease is known as ‘Leveraged Lease’.
HIRE PURCHASE AND INSTALMENT SALE
Meaning
In a hire purchase and in instalment sale, a buyer purchases goods but pays the price of the goods not in one lump sum but in various instalments. The buyer takes possession of the goods and enjoys them as if he is the sole owner of the goods, although, the price for the goods is not fully paid.
The person who purchases goods on hire purchase basis is called ‘hirer’; while the seller is called ‘hire purchase seller ’, ‘hire purchase vendor’ or ‘owner’. The hire purchase agreement must be in writing. It includes the description of the goods, cash price, interest to be charged, number of instalments and so on. The hire purchase price consists of two elements:
(1) Cash price and
(2) Interest for delayed payments.
Normally, a certain amount is paid immediately at the time of signing the agreement. This is called
‘Down’ payment.
Distinction Between Hire Purchase and Instalment Sale
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Hire Purchase
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Instalment Sale
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1.
Ownership
The
agreement mentions the date on which ownership in the goods passes
to
the buyer. Usually, it passes on payment of the last instalment.
|
Ownership
passes to the buyer
as
soon as the transaction of instalment sale is completed.
|
|
2.
Default in payment of instalment
In
case of a default, the seller can take
back the possession of the goods and he is not bound to return the amount already received.
|
The
seller cannot take back the goods. He can sue
the buyer for non-payment of instalment.
|
|
3. Buyer’s right to terminate contract The buyer has an option to terminate the contract and return the goods.
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The buyer has no right to terminate the contract.
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|
4. Buyer’s right to dispose of goods He cannot dispose of the goods as ownership has not passed on to him.
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Since the buyer is the sole owner of the goods, he can dispose of these goods in any manner he likes.
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5.
Loss of Goods
Loss of goods has to be borne by the seller provided the buyer
has taken reasonable care of the goods.
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As
he is the sole owner, any loss of goods has to be
borne by him.
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