Get AHSEC Class 12 Finance Chapter: 14 LEASE FINANCE Important Questions Answers 2025.
In this Post we have provided HS 2nd Year Finance Chapter: 14 LEASE FINANCE Important Notes with Marked/highlighted previous year questions asked in AHSEC Examination.
AHSEC Class 12 Finance Notes
Chapter: 14 LEASE FINANCE
1. Define lease finance? Who are the parties involved in it?
Ans: Meaning: A lease is a contract between two parties: the owner of an asset (lessor) and the user of the asset (lessee). In this agreement, the lessor provides the lessee with the right to use an asset for an agreed period in exchange for payment, usually in the form of rent. Definitions:
According to the Dictionary of Business Management, a lease is a contract transferring the use of land, space, structure, or equipment, with payment typically in the form of rent. James C. Van Horne defines lease as a contract where the owner (lessor) lets another party (lessee) exclusively use an asset for an agreed period in return for rent. International Accounting Standard IAS-17 states that a lease is an agreement where the lessor gives the lessee the right to use an asset for a set time in exchange for rent. The Institute of Chartered Accountants of India (AS-19) describes a lease as an arrangement where the lessor lets the lessee use an asset for a specific period in exchange for payments.
TYPES OF LEASE: There are two types of lease: (a) Finance Lease and (b) Operating Lease
2. What do you mean by finance lease? What are its features/characteristics?
Ans: A finance lease, also called a capital lease or long-term lease, involves a lessee making payments to lessor that exceed the equipment’s purchase price. These payments are spread over a period similar to the equipment’s useful life. According to AS-19, a finance lease transfers most risks and rewards of ownership, including losses from idle capacity or obsolescence and the potential for profitable operation and value appreciation. It’s suitable for assets like aircraft, real estate, heavy machinery and more. Features/Characteristics of Finance Lease:
i. Ownership Transfer: In finance lease, the lessor transfers asset ownership to the lessee by lease end, but remains owner during the lease term.
il. Lessee Purchase Option: Lessee can buy the asset at a lower price, typically lower than fair value when the option is active.
iii. Economic Life Coverage: Lease term aligns with the asset’s major economic life portion.
iv. Lease Payment Present Value: Initial lease period’s payment value must exceed or closely match asset’s fair value.
v. Specialized Asset Nature: Specialized nature of Asset restricts its use to the lessee without major alterations.
vi. Lessee’s Compensation to Lessor: Lessee must compensate lessor for losses if lease is canceled, as allowed by agreement.
vii. Gain/Loss Sharing: Lessee bears gain/loss from fair value fluctuations of the residual.
viii. Lease Extension: Lessee can extend lease with lower secondary-period rent.
ix. Maintenance and Obsolescence: Lessee handles maintenance and obsolescence risk during
X. Non-Cancellable: Finance lease is generally non-cancellable before its end date the lease.
xi. Ownership and Use Separation: Finance lease separates asset ownership and use during lease tenure.
3. What is Operating Leas? What Situations are suitable for Operating Lease? Explain its features/characteristics?
Ans: An operating lease is a type of lease where the lessor retains ownership risks and rewards. It’s also called a service or short-term lease. The lease duration is shorter than the equipment’s expected life and termination is possible with proper notice. Lease rentals are typically higher. It’s suitable for equipment sensitive to obsolescence and for resolving temporary problems.
Suitable Situations for Operating Lease:
(i) Computers, office equipment, vehicles and material handling equipment prone to obsolescence.
(ii) When the lessee needs to address temporary problems.
Features/Characteristics of Operating Lease:
(i) Period of Lease: In operating lease, the lease agreement has a duration shorter than the full useful life of the asset.
(ii) Cancellable Lease: Operating lease is cancellable, with a clause allowing the lessee to terminate the contract by giving notice to the lessor.
(iii) Maintenance Responsibility: The lessor is responsible for properly maintaining the asset.
(iv) Risk of Obsolescence: The lessor assumes the risk of asset obsolescence, as the lessee can terminate the lease due to asset obsolescence.
(v) No Extension of Credit: Operating lease doesn’t involve extending credit or making long-term commitments.
(vi) Lessor’s Re-Lease/Selling Right: The lessor can re-lease or sell the asset, gaining from successive transactions.
(vii) Lease Renewal Option: Lessees usually have the choice to renew the lease after the initial period ends. (vill) High Lease Rental: Operating lease features high lease rentals due to its short-term and cancellable nature.
4. What are the differences between finance lease and operating lease?
Ans:-
| Aspect | Finance Lease | Operating Lease |
| Ownership | Lessee typically gains ownership at the end of the lease term. | Ownership usually remains with the lessor. |
| Accounting Treatment | Recorded on the lessee’s balance sheet as an asset and liability. | Not typically recorded on the lessee’s balance sheet; expenses are recognized in the income statement. |
| Asset Depreciation | Lessee typically depreciates the asset. | Lessors usually handle asset depreciation. |
| Lease Term | Generally, long-term leases with most of the asset’s economic life. | Typically short-term leases, closer to the asset’s expected useful life. |
| Purchase Option | Often includes a purchase option at the end of the lease term. | Usually no or minimal purchase option. |
| Risk and Rewards | Lessee bears most of the risks and rewards associated with ownership. | Less risk and rewards for the lessee, as the lessor retains ownership. |
5. What are the advantages of Lease Finance to the Lessor and Lessee?
Ans: Advantages of Lease Finance to the Lessor: a. Additional Financial Product: Leasing offers finance companies and banks a new product, diversifying their activities.
b. Risk Transfer: In finance lease, the lessor transfers all risks, including obsolescence and maintenance, to the lessee.
c. Increased Profitability: The lessor can raise profits by charging depreciation and investment allowances against income.
d. Sales Boost: Manufacturers that offer leasing can increase sales by providing leasing options to customers.
e. Immediate Profit: Leasing companies start earning profit from the first year through lease rentals. f. Cost Efficiency: Leasing businesses can operate with minimal staff and low operating costs.
g. Repossession Right: Lessor has the right to repossess leased property in case of lessee’s payment default. h. Tax Advantages: As the lessor remains the owner, they enjoy tax benefits on depreciation and Investment allowances.
Advantages of Lease Finance to the Lessee:
a. Additional Funding Source: Leasing lets lessees acquire expensive assets without external borrowing.
b. Debt-Equity Ratio Stability: Lessee’s debt-equity ratio remains steady as leasing avoids borrowing from outside sources.
c. End-of-Term Acquisition: A finance lease lets lessees buy the asset at the lease term’s end. d. Easy Asset Acquisition: Operating lease shifts obsolescence risk and maintenance responsibility to the Tessor.
e. Technology Access: Operating lease ensures asset replacement with improved ones, providing access to advanced technology.
f. Lower Operating Costs: Operating lease lowers lessee’s operating costs as the lessor bears maintenance expenses,
6. What are the disadvantages of Lease Finance to the Lessor and Lessee?
Ans: Disadvantages of Lease Finance to the Lessor: asset’s residual value is low process for the lessor.
c. Maintenance and Obsolescence Responsibility: In operating lease, the lessor is responsible for handling
a. Loss on Repossession: Repossessing an asset due to lessee’s default can lead to loss, especially if the b. Repossession Challenges: Repossession of an asset because of missed payments can be a complicated obsolescence risk and maintenance costs. Disadvantages of Lease Finance to the Lessee:
a. Limited Applicability: Lessees can’t use leasing for project finance, as lease payments begin right after financing, which doesn’t suit projects needing time to start.
b. Depreciation and Investment Allowance Loss: Lessees don’t enjoy benefits like depreciation and investment allowances on leased assets since the assets belong to the lessor.
c. Shorter Asset Use Period: Operating lease allows lessees to use the asset for a shorter period than its full economic life.
7. Very Short Answer Questions:/State wether True/False:
(i) Is finance lease a cancellable lease?
Ans: No.
(ii) is operating lease a short-term lease?
Ans: Yes.
(ii) In an operating lease, the lessor bears the risk of obsolescence of the asset.
Ans: True.
(iv) Operating lease involves extending credit and making long-term commitments
Ans: False.
(v) A lessor has the right to repossess the leased property for default in payment of lease rentals by the lessee.
Ans: True.
(vi) In a finance lease, a lessee can acquire the asset at the end of the lease term.
Ans: True.
(vi) Operating lease shifts maintenance costs and obsolescence risk to the lessee.
Ans: False.
(vill) The lessor can’t increase profits through charging depreciation and investment allowances in lease finance.
Ans: False.
(ix) Leasing avoids disturbing the lessee’s debt-equity ratio.
Ans: True.
(x) A disadvantage of lease finance to the lessee is the limited scope in project finance situations.
Ans: True.
(x) A lessee enjoys depreciation and investment allowance benefits on leased assets.
Ans: False.
(xiii) in an operating lease, the lessee uses the asset for a longer period than its full economic life. Ans: False.
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