Question

Explain the differences between purchasing an asset and leasing an asset. What are some "good" reasons for opting to lease rather than purchase an asset? What are typical incremental cash flows, and how do you determine the net advantage to leasing

Answer 1

Difference between purchasing an asset and leasing an asset

Purchasing an asset means buying an asset by the business by making lumpsum payment or via instalment. A business organization or a firm can purchase an asset with their own internally accrued fund or by borrowing to finance purchase. On the other hand, leasing is a contractual agreement between lessor and lessee. Lessor is the owner of the asset who allows the lessee to use the asset for a specific period of time in return for periodic payment.

The following are some of the key differences between buying an asset and leasing an asset

· Buying refers to the purchase of an asset by paying the lumpsum price or by instalment. Leasing basically a rental agreement between lessor and lessee. Where, lessor is the owner and lessee are the user of the asset. Lessee has to pay a prefix amount to the lessor for using the asset.

· Buying involve total cost of owning the asset. leasing involves only the cost of using the asset.

· in purchasing an asset, here buyer takes care of all the risk associated with damage to the asset, repair and maintenance. But leasing, if it is operating leasing lessor takes care of all the risk arising out of damage and also all the repair expenses. But in finance leasing, lessee bear of all the expenses related to repair and maintenance

· purchased asset usually shown under asset category of the balance sheet of the buyer. In case of operating lease, it is shown only rental payment are debited from the income statement. In case of finance lease, at the inception of lease lessee will add an equal amount to both asset and liabilities on the balance sheet and over the term of the lease, the lessee will recognize depreciation expenses on the asset and interest expenses on the liability.

Reason for opting to lease rather than purchase an asset

1. leasing of an asset having more flexibility with easy upgrades. Technology is evolving more and more rapidly. Most leases provide an opportunity to upgrade as a part of the agreement. We don’t have to worry about getting rid of all the equipment as it is returned to the lessor.

2. Through leasing an asset, we can avoid the fewer of responsibilities of ownership of the asset. Buying guarantees the ownership of the asset, this is not necessarily a benefit. By having full ownership, we are responsible for everything that happens to the asset. But leasing avoid fewer of responsibility of the asset.

3. Leasing isn’t more expensive. Leasing do have the addition of interest to pay, they are not necessarily more expensive than paying a big lump sum. There are also tax reason, cashflow reason and other cost of ownership that we can say leasing isn’t more expensive.

4. Leasing build business relationship. When the leasing agreements ends, there is still a relationship between you and your supplier. When we start a lease, we gain access to lot of other referral opportunities. Once we build a relationship with a supplier, we may able to connect more of their clients or we can expand other parts of our business with many contracts and other dealing.

Advantages of leasing

· For leasing, less cash investment is required when comparing to purchasing an asset. Buying involve payment of a big lumpsum.

· Leasing require lower monthly payments.

· Depending on the lease structure chosen, the payment for the lease may be expensed rather than capitalized

· Leasing avoid technological obsolescence. It requires replacement in three to five year

· Leasing is a fixed rate of financing. No need to worry about raising interest rates throughout the contract term

· Leasing conserve our capital. It conserves for alternative uses including investment and improvements