Different types of lease structures Essay
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Different types of lease structures
There are two main forms of leases are operating and financial leases. Financial leases offer you an very significant financing option in cases where you do not have the required amount of financial capital to make initial investments on much needed plant, equipments or machinery. Our organization serves to ensure that you are able to enter into a lease agreement to acquire financing at an agreed upon rental payments structure. This is what is referred to as a finance lease. The elements that serve to create variations in the different types of lease structures include:
- The extent of ownership risk as well as the rewards conveyed to you or your organization as the lessee.
- The number of parties privy to a given lease agreement.
- The location of the lessee, lessor as well as the equipment supplier.
- The lessee and the lessor.
Step-up leases ensure you are in a position to enter into a lease agreement whose rental rate increases in predetermined rates at definite future points. As lessors, we hedge against such future rent increases through risks like rising cost and inflation. Step-up lease run for several years.
Fair Market Value
Also referred to as the true lease, this lease option is quite appropriate for you as a client who seeks to own or otherwise upgrade plant, equipment or machinery at the end of a lease agreement. In this case, monthly payments on rent are made across the lease agreement’s life. Most agreements run over a period of 36, 48 and 60 months as desired by the lessee. At the end of the lease period, the lessee can opt to return the leased asset, purchase the asset at FMV not exceeding 10% of original asset cost or renew the lease agreement for one more year.
Dollar Purchase Option
This is also referred to as the conditional sale contract. This lease option is appropriate in cases where the asset will not depreciate in value over the course of its life. Monthly payments are generally higher than for the FMV lease as the asset is paid off in the course of the lease agreement such that you can purchase the asset at 1$ at the end of the agreement.
The Terminal Rental Adjustment Clause (TRAC) lease structure incorporates all lease benefits while retaining the option for the lessee to buy the asset at the end of the lease agreement at a residual price pre-determined before the lease begins. This residual price determines the monthly payments and offers a flexible lease structure for businesses opting to improve on cash flow management. This is because monthly payments can be made lower by increasing the residual price.
Capital lease (on balance sheet) versus Operating Lease (off balance sheet)
The way with which you account for a lease determines whether or not it is referred to as a capital or operating lease. An operating lease does not convey any risk to the lessee and is considered as an operating cost or expense in the lessee’s income statement thus has no effect on the balance sheet. For a capital lease, the lessee acquires an increased degree of risk of ownership and enjoys a number of advantages. These include transferring ownership of a given asset at the end of the lease agreement, a bargain option to buy the asset at FMV and tax deductions for asset depreciation and accounting as an interest expense. The risks include, the lessee having to pay for insurance costs, maintenance and tax and the lease payments accounted for as liabilities.