1. Leasing

2. Leasing
A lease is a contact between the owner of an asset (the lessor) and the party desiring to use that asset (the lessee).
Generally, leases provide for the following terms:
The lessor allows the lessee the unrestricted right to use the asset during the lease term.
The lessee agrees to make periodic payments to the lessor and to maintain the asset.
Title to the asset remains with the lessor, who usually retakes possession of the asset at the conclusion of the lease.

3. Lease (Van Horne) A lease is a contract
By its terms the owner of an asset (the lessor) gives another party (the lessee) the exclusive right to use the asset, usually for a specified period of time, in return for the payment of rent.
Leases of houses, apartments, offices, cars, trucks, computers, machinery and manufacturing plants.

4. Types of Lease According to maintenance According to Time Period
Full-Service (or maintenance) lease
Lessor pays for maintenance, repairs, taxes and insurance.
Net lease
Lessee pays these costs.
According to Time Period
Operating Lease
Short term
Cancelable at the option of the lessee with proper notice.
Shorter then the asset’s economic life.
Financial Lease
Long term
Noncancelable
Lease payments, amortization, interest return.

5. Form of Lease Financing (Financial)
Sale and Leaseback
Direct Leasing
Leveraged Leasing

6. 1. Sale and Leaseback
The sale of an asset with the agreement to immediately lease it back for an extended period of time.
Asset is sold at approximately its market value.
The selling firm receives the cash and acquire the economic use of the asset.
The lessee firm makes periodic lease payments.
Lessor realizes any residual value.

7. 2. Direct Leasing
Under direct leasing a company acquires the use of an asset it did not own previously.
A firm may lease an asset from manufacturer.
Lessors are manufacturers, companies, banks, independent leasing companies, special purpose leasing companies and partnerships.

8. 3. Leveraged Leasing
In leveraged leasing there are three parties involved instead of two.
Lessee, Lessor and Lender
Lessee role is the same but lessor role changed
Lessor act as an ‘equity participant’ and borrower as well.
A lease agreement in which the lessor provides an equity portion (usually 20 to 40 percent) of the leased asset’s cost and third-party lenders provides the balance of the financing.

9. 3. Leveraged Leasing An owner of the asset is lessor
He is entitled to deduct all depreciation charges associated with the asset.
Cash flow pattern for lessor
Cash outflow at acquiring the asset (equity participation)
Cash inflow (lease payments, tax benefits – payments on debts includes interest and principal.
At expiry of lease agreement
Lease payment + tax benefits < debt payment due
Residual value (sale)

10. Expiry of lease agreement
Return the lease asset to the lessor.
Renewal (same or changes terms).
Purchase of an asset at expiry of contract.
Value should not be significantly lower then its fair market value.
Residual value for lessor at expiration.

11. Advantages to Leasing
An obvious advantage to the lessee is the use of an asset without having to buy it.
Leases often require much less equity investment than bank financing.
Since leases are contracts between two willing parties, their terms can be structured in any way to meet their respective needs.
If properly structured, neither the leased asset not the lease liability are reported on the face of the balance sheet.

12. Basic Rule of Leasing Transferring of usufruct not ownership
To another person for an agreed price, at an agreed consideration.
Subject of lease
Valuable, Identified and Quantified
Consumable things cannot be leased out
Anything which cannot be used without consuming cannot be leased out; e.g., money, wheat etc.

13. Basic Rule of Leasing All Liabilities of ownership are borne by lessor
Since body of leased property remains in the ownership of the seller.
Period of lease
Must be determined in clear terms at the time of contract.
Lease for specific purpose only
If no specific purpose is identified in the agreement, then it can be used for any purpose for which it is used in normal course.

14. Basic Rule of Leasing Lessee as Ameen Lease of jointly owned property
The lessee is liable to compensate the lessor for every harm to the leased asset caused by any misuse or negligence. The leased asset shall remain in the risk of the lessor throughout the lease period.
Lease of jointly owned property
Is permitted and rentals shall be distributed between all the joint owners according to the proportion of their respective shares in the property.

15. Basic Rule of Leasing Determination of Rental
The rental must be determined at the time of contract for the whole period of lease.
It is permissible that different amounts of rent are fixed for different phases during the lease period, provided that the amount of rent for each phase is specifically agreed upon at the time of affecting a lease.
The determination of rental on the basis of the aggregate cost incurred in the purchase of the asset by the lessor, as normally done in financial leases, is not against the rules of Shariah.
The lessor cannot increase the rent unilaterally, and any agreement to this effect is void.
The rent or any part thereof may be payable in advance before the delivery of the asset to the lessee.
The lease period shall commence from the date on which the leased asset has been delivered to the lessee.

16. Lease as a mode of Financing
Leasing is not originally a mode of financing
Leasing should not be interest-based loan or replacing interest with rent, rather it should comply with all of the following conditions of Islamic leasing:

17. Lease as a mode of Islamic Finance
The commencement of lease
Unlike the contract of sale, the agreement of Ijarah can be effected for a future date. Hence, it is different from Murabaha.
Rent should be charged after the delivery of the leased asset to the lessee
and not from the day the price has been paid. If the supplier has delayed the delivery after receiving the full price, the lessee should not be liable for the rent of the period of delay.
Different relations of the parties
There are two separate relations between the institution and the client: one of an agent and the other of a lessee.

18. Lease as a mode of Islamic Finance
Difference between Murabahah and leasing
A Murabahah attributed to a future date is invalid in Shariah. But leasing can be attributed to a future date.
A Murabaha can not be transacted on a future date as the sale would be executed simultaneously after taking delivery from the supplier and seller would never bear its risk which Shariah does not permit . But in leasing it is permissible, because in leasing the asset remains under the risk and ownership of the lessor throughout the leasing period.

19. Lease as a mode of Islamic Finance
Expenses consequent to ownership to the lessor
As the lessor is the owner of the asset, he is liable to pay all the expenses incurred in the process of its purchase and its import to the country of the lessor for example expenses of freight and customs duty etc.
Lessee as Ameen
The lessee is responsible for any loss caused to the asset by his misuse or negligence. He can also be made liable to any normally occurring wear and tear.

20. Lease as a mode of Islamic Finance
Variable Rentals in Long Term Leases
In this case the lessor has two options:
A lease contract can have a condition that the rent shall be increased according to a specified proportion (e.g. 5%) after a specified period (like one year).
He can contract lease for a shorter period after which the parties can renew the lease at new terms and by mutual consent

21. Lease as a mode of Islamic Finance
Penalty for late payment of Rent
The lessor cannot charge an additional amount in case the lessee delays payment of the rent.
Penalty of late payment is given to charity by lessee

22. Lease as a mode of Islamic Finance
Termination of Lease
If the lessee breaks any term of the agreement, the lessor has a right to terminate the lease contract unilaterally. If not then it can be terminated through mutual consent only. However, in such a case he cannot charge rentals of remaining period.
Insurance of the assets
If the leased property is insured under the Islamic mode of Takaful, it should be at the expense of the lessor and not at the expense of the lessee

23. Lease as a mode of Islamic Finance
The residual value of the leased asset
Through a mutual agreement of Lease, after the expiry of the lease period, the corpus of the leased asset cannot be transferred to the lessee, otherwise it becomes hire purchase.
It is a well-settled rule of Islamic jurisprudence that one transaction cannot be tied up with another transaction so as to make the former a pre-condition for the other.
However, the lessor may enter into a unilateral undertaking to sell the leased asset to the lessee at the end of the lease period. This undertaking will be binding on the lessor only.

24. Lease as a mode of Islamic Finance
Ijarah Wa Iqtina
The lessor may sign a separate promise to gift the leased asset to the lessee at the end of the lease period, subject to his payment of all amounts of rent. The validity of this arrangement is subject to two basic conditions:
Firstly, the agreement of Ijarah itself should not be subjected to signing this promise of sale or gift.
Secondly, the promise should be unilateral and binding on the promisor only.
Sub-Lease
If the leased asset is used differently by different users, the lessee cannot sub-lease the leased asset except with the express permission of the lessor.

25. Conclusion LEASING IS NOT VERY DIFFERENT FROM CONVENTIONAL LEASE
Islamic Financial lease is very similar to conventional lease, however, it has some differences which are:
the rental rate decided at the time of the agreement cannot fluctuate
expenses under Ijarah are as follows:
Lessor- expenses relating to the corpus of the asset i.e. insurance, accidental repairs etc. will be borne by the lessor
Lessee- actual operating/overhead expenses related to running the asset will be borne by the lessee
two contracts into one contract is not permissible in Shariah therefore, we cannot have the agreement of hire and purchase into one agreement, only we can undertake/promise to purchase the leased asset

26. Reporting and Analyzing Off-Balance Sheet Financing

27. Why is Off-Balance Sheet Financing Important?
In other words, why are firms so interested in “hiding” debt?
If analysis reveals that debt is excessive, companies may face the prospect of a reductions in bond ratings, resulting in higher cost of debt.
Likewise, excessive leverage can result in a higher cost of equity capital and a consequent reduction in stock price.

28. “Window Dressing” Financial Statements: Examples # 1
A company’s level of accounts receivable are perceived to be too high, thus indicating possible collection problems and a reduction in liquidity.
Prior to the statement date, the company offers customers an additional discount in order to induce them to pay the accounts more quickly.
Although the profitability on the sale has been reduced by the discount, the company reduces its accounts receivable, increases its reported cash balance and presents a somewhat healthier financial picture to the financial markets.

29. “Window Dressing” Financial Statements: Examples # 2
The company’s financial leverage is deemed excessive, resulting in lower bond ratings and a consequent increase in borrowing costs.
To remedy the problem, the company issues new common equity and utilizes the proceeds to reduce the indebtedness.
The increased equity provides a base to support the issuance of new debt to finance continued growth.

30. Motives for using Off-Balance Sheet Financing
In general, companies desire to present a balance sheet with sufficient liquidity and less indebtedness.
The reasons for this are as follows: liquidity and the level of indebtedness are viewed as two measures of solvency.
Companies that are more liquid and less highly financially leveraged are generally viewed as less likely to go bankrupt.
As a result, the risk of default on their bonds is less, resulting in a higher rating on the bonds and a lower interest rate.

31. Off-Balance Sheet Financing
Off-balance sheet financing means that either liabilities are kept off of the face of the balance sheet.
In this module, we discuss leases.

32. Operating Lease Operating lease method.
Under this method, neither the lease asset nor the lease liability is on the balance sheet. Lease payments are recorded as rent expense when paid.

33. Benefits of Operating Leases
Leased asset is not reported on the balance sheet.
Lease liability is not reported on the balance sheet.
For the early years of the lease term, rent expense reported for an operating lease is less than the depreciation and interest expense reported for a capital lease.

34. Capital vs. Operating Leases
Capital lease method.
This method requires that both the lease asset and the lease liability be reported on the balance sheet. The leased asset is depreciated like any other long-term asset. The lease liability is amortized like a note, where lease payments are separated into interest expense and principal repayment.