Leasing & Hire purchase, factoring & forfeiting and venture capital

Let’s start with
the positive
energy…

LEASING
This Standard should be applied in accounting for
all leases other than:
 lease agreements to explore for or use natural resources, such
as oil, gas, timber, metals and other mineral rights; and
 licensing agreements for items such as motion picture films,
video recordings, plays, manuscripts, patents and copyrights
 lease agreements to use lands.
5

LEASING
 Introduction:
• Leasing is distinguished from most other forms of finance by the fact that the lessor is
the legal owner of the leased asset.
• The lessee obtains the right to use the asset in return for periodic payments (lease
rentals) to the lessor.
• Definition: “A lease is a form of contract transferring the use or occupancy of land,
space, structure or equipment in consideration of a payment, usually in form of a rent”
6

LEASING
According to as 19 “A lease is an agreement whereby the
lessor conveys to the lessee in return for a payment or
series of payments the right to use an asset for an agreed
period of time”
A finance lease is a lease that transfers substantially all
the risks and rewards incident to ownership of an asset
An operating lease is a lease other than a finance lease
7

LEASING
A non-cancellable lease is a lease that is
cancellable only:
 Upon the occurrence of some remote contingency
 with the permission of the lessor
 If the lessee enters into a new lease for the same or an
equivalent asset with the same lessor
 Upon payment by the lessee of an additional amount such that,
at inception, continuation of the lease is reasonably certain.
8

Concept of Leasing
• Leasing is an agreement between two parties, the leasing company or lessor and the user
or lessee.
• The rentals are predetermined and payable at fixed intervals of time, according to the
mutual convenience of both the parties.
• However, the lessor remains the owner of the equipment over the primary period.
• Lessor
• The legal owner
• Lessee
• Obtains the right to use the asset.

THE FOLLOWING IMPLICATIONS FOR THE LESSER AND LESSE
• The lesser has the duty to deliver the asset to the lessee,
• The lessee has the obligation to pay the lease rentals as specified in the lease agreement
10

CONTENTS OF LEASE AGREEMENT
• Description of the lessor, the lessee, and the equipment.
• Amount, time, and place of lease rental payments.
• Time and place of equipment delivery.
• Lessee’s responsibility for taking delivery and possession of the leased equipment.
• Lessee’s responsibility for maintenance, repairs, registration, etc.
11

TYPES OF LEASE
Financial
Lease
Operating
Lease
Leverage
Lease
Cross border
Lease
Wet & Dry
Lease
Vendor
Leasing
13

Financial Lease
 A financial Lease is also known as Capital lease, Long-term lease, Net lease & Close
lease
 Under a financial lease, the rate of lease would be fixed based on the kind of lease, the
period of lease, periodicity of rent payment, & the rate of depreciation & other tax
benefits available.
 The high cost of equipments such as office equipment, diesel generators, machine tools,
textile machinery, containers, locomotives etc., is leased under financial lease.
14

Financial Lease
 At the inception of a finance lease, the lessee should recognise the lease as an asset and
a liability.
 Such recognition should be at an amount equal to the fair value of the leased asset at
the inception of the lease.
 However, if the fair value of the leased asset exceeds the present value of the minimum
lease payments from the standpoint of the lessee,
 The amount recorded as an asset and a liability should be the present value of the minimum lease
payments from the standpoint of the lessee.
 In calculating the present value of the minimum lease payments the discount rate is the
interest rate implicit in the lease.

Financial Lease
 An enterprise (the lessee) acquires a machinery on lease from a leasing company (the
lessor) on January 1, 20X0. The lease term covers the entire economic life of the
machinery, i.e., 3 years. The fair value of the machinery on January 1, 20X0 is
Rs.2,35,500. The lease agreement requires the lessee to pay an amount of Rs.1,00,000
per year beginning December 31, 20X0. The lessee has guaranteed a residual value of
Rs.17,000 on December 31, 20X2 to the lessor. The lessor, however, estimates that the
machinery would have a salvage value of only Rs.3,500 on December 31, 20X2.
 The interest rate implicit in the lease is 16 per cent.

Financial Lease
This is calculated using the following formula:
Fair value =
𝐴𝐿𝑅
1+𝑟 1+
𝐴𝐿𝑅
1+𝑟 2 + … +
𝐴𝐿𝑅
1+𝑟 𝑛
+
𝑅𝑉
1+𝑟 𝑛
where ALR is annual lease rental,
RV is residual value (both guaranteed and unguaranteed)
 n is the lease term,
 r is interest rate implicit in the lease

Financial Lease
The present value of minimum lease payments from
the stand point of the lessee is Rs.2,35,480
 The lessee would record the machinery as an asset at Rs.2,35,480 with a corresponding
liability representing the present value of lease payments over the lease term (including
the guaranteed residual value)

Financial Lease
 In the above example, suppose the lessor estimates that the machinery would have a
salvage value of Rs.17,000 on December 31, 20X2. The lessee, however, guarantees a
residual value of Rs.5,000 only
 The interest rate implicit in the lease in this case would remain unchanged at 16% .
 The present value of the minimum lease payments from the standpoint of the lessee,
using this interest rate implicit in the lease, would be Rs.2,27,792.
 As this amount is lower than the fair value of the leased asset (Rs. 2,35,500), the lessee
would recognise the asset and the liability arising from the lease at Rs.2,27,792

OPERATING LEASE
An operating lease is also known as service lease, short-term lease
or true lease.
The lease is for a limited period may be in a month, six months, a
year or few years.
Normally, the lease rentals will be higher as compared to other
leases on account of short period of primary lease.
20

OPERATING LEASE
 Lease payments under an operating lease should be recognised as an expense in the
statement of profit and loss on a straight line basis over the lease term unless another
systematic basis is more representative of the time pattern of the user’s benefit.
 The lessor should present an asset given under operating lease in its balance sheet under
fixed assets.
 Lease income from operating leases should be recognised in the statement of profit and loss
on a straight line basis over the lease term
21

LEVERAGE LEASE
A leverage lease is used for financing those assets which require
huge capital outlay.
The outlay for purchase cost is generally from 50 lakhs to 2
crore.
Asset has economic life of 10 years or more.
The Lessor acquires the assets as per the terms of the lease
agreement but finances only a part of the total investment, say 20%-
50%
22

Two ways of
evaluating…………………
1. Lessee’s point
of view
2. Lessor’s point
of view

Lessee’s point of view:
Lease or borrow decisions:
Steps:
Calculate present value of net-cash flow
of the buying option-NPV(B)
Calculate present value of net cash flow
of the leasing option-NPV(L)
Decide whether to buy or lease the asset
or reject the proposal .

How to decide…….
If NPV(B) is positive and greater than NPV(L) then

• If NPV(L) is positive and greater
than the NPV(B)
then lease the asset.

• If NPV(B) as well as NPV(L)
are both negative,
reject the proposal

From the lessor’s point of view
Present value Internal rate
method of return
method

Present value method
• Determine cash outflows by deducting tax advantage of owing an asset.
• Determine cash inflows after tax.
• Determine the present value of cash outflows and after tax cash inflows by discounting at weighted
average cost of capital of the lessor.
• Decide in favour of leasing out an asset if p.v. of cash inflows exceeds the p.v. of cash outflows i.e. if
the NPV is positive

Internal rate of return method
• Rate of discount at which the present value of cash inflows is equal to the present
value of cash outflows.
• Can be determined with the help of mathematical formula.
• Can also be determined with the help of present value tables.

ADVANTAGES OF LEASING
• Permit alternative use of funds
A leasing arrangement provides a firm with the use and control over asset without
incurring huge capital expenditure.
• Faster and cheaper credit
Acquisition of assets under leasing agreement is cheaper and faster than any other source
of finance.
31

• Flexibility
Leasing arrangements may be tailored to the lessee’s needs more easily than ordinary financing.
The lessee can utilize more funds for working capital needs.
• Facilitates additional borrowings
Leasing may increase long-term ability to acquire funds. The lessee can utilize more funds for
working capital needs.
• Protection against obsolescence
A firm can avoid risk of obsolescence by entering into operating lease agreement.
32

• No restrictive covenants
The restrictive covenants which are usually imposed under debenture or loan agreement are
absolutely absent in a lease agreement.
• Hundred percent financing
Lease financing enables a firm to acquire the use of an asset without having to make a down
payment. So, hundred per cent financing is assured to the lessee.
• Boom to small firm
It is a boon to small firms and technocrats who are able to make promoters contribution as
required by financial institutions.
33

DISADVANTAGES OF LEASING
• Lease is not a suitable mode of project finance
• Certain tax benefits/incentives such as subsidy may not be available on leased equipment.
• The value of real assets such as land and building may increase during lease period. In
such a case, the lessee loses the advantage of a potential capital gain.
• The cost of financing is generally higher than that of debt financing.
34

•A manufacturer who wants to discontinue a particular line of business
will not in a position to terminate the contract except by paying heavy
penalties.
•In case of lease agreement, it is lessor who has purchased the asset
from the supplier and not the lessee.
•If the lessee is not able to pay rentals regularly, the lesser would suffer
a loss particularly when the asset is a sophisticated one and less
liquid.
• In the absence of exclusive laws dealing with the lease transaction,
several problems crop up between lesser and lessee resulting in
unnecessary complications and avoidable tensions.
35

What are the criteria for a
capital lease?
• A capital lease is a lease in which the lessor only finances the
leased asset, and all other rights of ownership transfer to
the lessee.
• This results in the recordation of the asset as the lessee's
property in its general ledger, as a fixed asset.
• The lessee can only record the interest portion of a capital
lease payment as expense, as opposed to the amount of the
entire lease payment in the case of the more common
operating lease.

capital lease?
• The criteria for a capital lease can be any one of the following four
alternatives:
• Ownership. The ownership of the asset is shifted from the lessor to the
lessee by the end of the lease period; or
• Bargain purchase option. The lessee can buy the asset from the lessor
at the end of the lease term for a below-market price; or
• Lease term. The period of the lease encompasses at least 75% of the
useful life of the asset (and the lease is noncancellable during that
time); or
• Present value. The present value of the minimum lease payments
required under the lease is at least 90% of the fair value of the asset at
the inception of the lease

capital lease?
• If a lease agreement contains any one of the preceding four
criteria, the lessee records it as a capital lease.
• Otherwise, the lease is recorded as an operating lease. The
recordation of these two types of leases is as follows:
• Capital lease. The present value of all lease payments is
considered to be the cost of the asset, which is recorded as a
fixed asset, with an offsetting credit to a capital lease liability
account. As each monthly lease payment is made to the
lessor, the lessee records a combined reduction in the capital
lease liability account and a charge to interest expense. The
lessee also records a periodic depreciation charge to
gradually reduce the carrying amount of the fixed asset in its
accounting records.

capital lease?
• Operating lease. Record each lease payment as an expense.
There is no other entry.
• Given the precise definition of a capital lease, the parties to a
lease are usually well aware of the status of their lease
arrangement before a lease is signed, and typically write the
lease agreement so that the arrangement will be clearly
defined as either a capital lease or operating lease.

E21-1 (Capital Lease with Unguaranteed Residual Value) On
January 1, 2007, Burke Corporation signed a 5-year noncancelable
lease for a machine. The terms of the lease called for Burke to
make annual payments of $8,668 at the beginning of each year,
starting January 1, 2007. The machine has an estimated useful life
of 6 years and a $5,000 unguaranteed residual value. Burke uses
the straight-line method of depreciation for all of its plant assets.
Burke’s incremental borrowing rate is 10%, and the Lessor’s
implicit rate is unknown.
LO 2 Describe the accounting criteria and procedures
for capitalizing leases by the lessee.
Accounting by the Lessee
Instructions
(a) What type of lease is this? Explain.
(b) Compute the present value of the minimum lease payments.
(c) Prepare all journal entries for Burke through Jan. 1, 2008.

E21-1 What type of lease is this? Explain.
Capitalization Criteria:
1. Transfer of ownership
2. Bargain purchase option
3. Lease term => 75% of
economic life of leased
property
4. Present value of minimum
lease payments => 90% of
FMV of property
NO
NO
Lease term 5 yrs.
Economic life 6 yrs.
YES 83.3%
FMV of leased
property is unknown.
Capital Lease, #3

E21-1 Compute present value of the minimum lease payments.
Payment $ 8,668
Present value factor (i=10%,n=5) 4.16986
PV of minimum lease payments $36,144
Journal entry
1/1/07 Leased Machine Under Capital Lease 36,144
Leases liability 36,144
Leases liability 8,668
Cash 8,668

E21-1 Lease Amortization Schedule
10%
Lease Interest Reduction Lease
Date Payment Expense in Liability Liability
1/1/07 36,144$
1/1/07 8,668$ 8,668$ 27,476
12/31/07 8,668 2,748 5,920 21,556
12/31/08 8,668 2,156 6,512 15,044
12/31/09 8,668 1,504 7,164 7,880
12/31/10 8,668 788 7,880 0

E21-1 Journal entries for Burke through Jan. 1, 2008.
Journal entry
12/31/07 Depreciation expense 7,229
Accumulated depreciation 7,229
($36,144 ÷ 5 = $7,229)
Interest expense 2,748
Interest payable 2,748
[($36,144 – $8,668) X .10]

E21-1 Journal entries for Burke through Jan. 1, 2008.
Journal entry
1/1/08 Lease liability 5,920
Cash 8,668

E21-1 Comparison of Capital Lease with Operating Lease
LO 3 Contrast the operating and capitalization methods of recording leases.
E21-1 Capital Lease Operating
Depreciation Interest Lease
Date Expense Expense Total Expense Diff.
2007 7,229$ 2,748$ 9,977$ 8,668$ 1,309$
2008 7,229 2,156 9,385 8,668 717
2009 7,229 1,504 8,733 8,668 65
2009 7,229 788 8,017 8,668 (651)
2010 7,228 7,228 8,668 (1,440)
36,144$ 7,196$ 43,340$ 43,340$ 0
*
rounding
*

E21-10 (Computation of Rental) Morgan Leasing Company signs an
agreement on January 1, 2007, to lease equipment to Cole
Company. The following information relates to this agreement.
1. The term of the non cancelable lease is 6 years with no renewal option.
The equipment has an estimated economic life of 6 years.
2. The cost of the asset to the lessor is $245,000. The fair value of the asset
at January 1, 2007, is $245,000.
3. The asset will revert to the lessor at the end of the lease term at which time
the asset is expected to have a residual value of $43,622, none of which is
guaranteed.
4. The agreement requires annual rental payments, Jan. 1, 2007.
5. Collectability of the lease payments is reasonably predictable. There are
no important uncertainties surrounding the amount of costs yet to be
incurred by the lessor.
Accounting by the Lessor

LO 4 Identify the classifications of leases for the lessor.
Residual value 43,622$
PV of single sum (i=10%, n=6) 0.56447
PV of residual value 24,623$
Fair market value of leased equipment 245,000$
Present value of residual value (24,623)
Amount to be recovered through lease payment 220,377
PV factor of annunity due (i=10%, n=6) 4.79079
Annual payment required 46,000$
E21-10 (Computation of Rental) Assuming the lessor desires
a 10% rate of return on its investment, calculate the amount
of the annual rental payment required.
÷
x
-

E21-10 Prepare an amortization schedule that would be
suitable for the lessor.
10% Recovery
Lease Interest of Lease
Date Payment Revenue Receivable Receivable
1/1/07 245,000$
1/1/07 46,000$ 46,000$ 199,000
12/31/07 46,000 19,900 26,100 172,900
12/31/08 46,000 17,290 28,710 144,190
12/31/09 46,000 14,419 31,581 112,609
12/31/10 46,000 11,261 34,739 77,870
12/31/11 46,000 7,787 38,213 39,657
12/31/12 43,622 3,965 39,657 0
*rounding
*
LO 5 Describe the lessor’s accounting for direct-financing leases.

E21-10 Prepare all of the journal entries for the lessor for
2007 and 2008.
Journal entry
1/1/07 Lease receivable 245,000
Asset 245,000
1/1/07 Cash 46,000
Lease receivable 46,000
12/31/07 Interest receivable 19,900
Interest revenue 19,900

E21-10 Prepare all of the journal entries for the lessor for
2007 and 2008.
Journal entry
1/1/08 Cash 46,000
Interest receivable 19,900

Illustration (LESSEE and LESSOR Computations and Entries) On
Jan. 1, 2007, Velde Company (lessee entered into a four-year,
noncancellable contact to lease a computer for Exceptional
Computer Company (lessor). Annual rentals of $16,228 are to be
paid each Jan. 1. The cost of the computer to Exceptional
Computer Company was $60,000 and has an estimated useful life
of four years and a $5,000 residual value. Velde has guaranteed
the lessor a residual value of $5,000. Velde has an incremental
borrowing rate of 12% but has knowledge that Exceptional
computer Company used a rate of 10% in setting annual rentals.
Collection of the rentals is reasonably predictable and there are
no important uncertainties regarding future unreimbursable costs
to be incurred by the lessor.
Special Accounting Problems
LO 7 Describe the effect of residual values, guaranteed and
unguaranteed, on lease accounting.

Illustration (LESSEE) What is the present value of the
minimum lease payments?
Payment 16,228$
PV of annunity due (i=10%, n=4) 3.48685
PV of residual value 56,585
Residual value 5,000
PV of residual value 3,415
Total Present Value 60,000$

Illustration (LESSEE) What type of lease is this? Explain.
Capitalization Criteria:
1. Transfer of ownership
2. Bargain purchase option
3. Lease term => 75% of
economic life of leased
property
4. Present value of minimum
lease payments => 90% of
FMV of property
NO
NO
Lease term 4 yrs.
Economic life 4 yrs.
YES 100%
FMV of leased
property is unknown.
Capital Lease, #3

Illustration (LESSEE) Prepare an amortization schedule that
would be suitable for the Velde.
10%
Lease Interest Reduction of Lease
Date Payment Expense Liability Liability
1/1/07 60,000$
1/1/07 16,228$ 16,228$ 43,772
12/31/07 16,228 4,377 11,851 31,921
12/31/08 16,228 3,192 13,036 18,885
12/31/09 16,228 1,889 14,339 4,546
12/31/10 5,000 454 4,546 0
*
rounding
*

Illustration (LESSEE) Prepare all of the journal entries for
the Velde for 2007 and 2008.
Journal entry
1/1/07 Lease computer 60,000
Lease liability 60,000
1/1/07 Lease liability 16,228
Cash 16,228
12/31/07 Interest expense 4,377
Accumulated Depreciation 13,750
($60,000 – 5,000) / 4 = $13,750

Illustration (LESSEE) Prepare all of the journal entries for
the Velde for 2007 and 2008.
Journal entry
1/1/08 Interest payable 4,377
Lease liability 11,851
Cash 16,228
12/31/08 Interest expense 3,192
Accumulated Depreciation 13,750

Residual value 5,000$
PV of residual value 3,415$
Cost of equipment to be recovered 60,000$
Present value of residual value (3,415)
Amount to be recovered through lease payment 56,585
PV factor of annunity due (i=10%, n=4) 3.48685
Annual payment required 16,228$
Illustration (LESSOR) Calculation of the annual rental
payment.
÷
x
-

Illustration (LESSOR) Prepare an amortization schedule
that would be suitable for the Exceptional.
10% Recovery
Lease Interest of Lease
Date Payment Revenue Receivable Receivable
1/1/07 60,000$
1/1/07 16,228$ 16,228$ 43,772
12/31/07 16,228 4,377 11,851 31,921
12/31/08 16,228 3,192 13,036 18,885
12/31/09 16,228 1,889 14,339 4,546
12/31/10 5,000 454 4,546 0
*
rounding
*

Illustration (LESSOR) Prepare all of the journal entries for
the Exceptional for 2007 and 2008.
Journal entry
1/1/07 Lease receivable 60,000
Equipment 60,000
1/1/07 Cash 16,228

Journal entry
1/1/08 Cash 16,228
Interest receivable 4,377
Illustration (LESSOR) Prepare all of the journal entries for
the Exceptional for 2007 and 2008.

Methods of determining lease rental
First we will take one example then we understand

The following data are furnished by the Hypothetical
Leasing Ltd (HLL):
• Investment cost Rs 500 lakh
• Primary lease term 5 years
• Estimated residual value after the primary period Nil
• Pre-tax required rate of return 24 per cent
• The HLL seeks your help in determining the annual lease
rentals under the following rental structures:
• Equated
• Stepped (an annual increase of 15 per cent),
• Ballooned (annual rental of Rs 80 lakh for years 1–4)

• Solution
• Equated annual lease rentals, Y:
• Y = Investment cost/PVIFA (24, 5 years) = Rs 500
lakh/2.745 = Rs 182.15 lakh
• Stepped lease rental (assuming annual increase of 15 per
cent annually), Y:
• Y × PVIF(24, 1) + (1.15)Y × PVIF(24, 2) + (1.15)2Y ×
PVIF(24, 3) + (1.15)3Y × PVIF(24, 4) + (1.15)4Y ×
PVIF(24, 5) = Rs 500 lakh.
• 0.806Y + 0.7475Y + 0.693Y + 0.6433Y + 0.5894Y = Rs
500 lakh
• 3.4792Y = Rs 500 lakh or Y = Rs 500 lakh/3.4792 =
Rs 143.71 lakh

• Lease rentals (year-wise) (in lakh of rupees)
• Year 1 2 3 4 5
• Lease rent 143.71 165.26 190.05 218.56 251.34
• Ballooned lease rental (Rs 80 lakh for years, 1 – 4)
• Rs 80 lakh × PVIFA(24, 4), + Y × PVIF (24, 5) = Rs
500 lakh
• Rs 80 lakh × 2.404 + 0.341Y = Rs 500 lakh
• 0.341Y = Rs 500 lakh – Rs 192.32 lakh = Rs 307.68
lakh
• or Y = Rs 307.68/0.341 = Rs 902.29 lakh (ballooned
payment)

HIRE PURCHASE
 Introduction:
• Hire Purchase is the legal term for a contract, in which persons usually agree to pay for
goods in parts or a percentage at a time.
• When a sum equal to the original full price plus interest has been paid, the buyer may
then exercise an option to buy the goods or return the goods to the owner.
66

Meaning
The hire purchase Act of India 1972,
defines a hire purchase agreement as an
agreement under which goods are let on
hire and under which the hirer has an
option to purchase them in accordance
with the terms of agreement.

It involves two parties:
Hirer: The party which receives the asset.
Hiree: The party which rents out the asset.

Hire Purchase Agreement
HP agreements must be in writing and signed by both the parties.
They must clearly lay out the following information:
 A clear description of the goods
 The cash price for the goods
 The HP price
 The deposit
 The monthly installments
 Rights to parties
70

FEATURES OF HIRE PURCHASE
• Possession of goods
• Each installment is treated as hire charges.
• Ownership
• Default in the payment
• Terminate the agreement
71

Hirer’s obligations
•To pay the hire installments
•To take reasonable care of the goods (if the hirer
damages the goods by using them in a non-standard
way, he or she must continue to pay the installments and,
if appropriate, compensate the owner for any loss in
asset value)

•To inform the owner where the goods will be kept.
•A hirer can sell the products if, and only if, he has
purchased the goods finally or else not to any other third
party.
•It is pretty much similar to installment but the main
difference is of ownership.

Rights of the Owner
•The owner usually has the right to terminate the agreement
where the hirer defaults in paying the installments or breaches
any of the other terms in the agreement.
•This entitles the owner: to forfeit the deposit to retain the
installments already paid and recover the balance due to
repossess the goods (which may have to be by application to a
Court depending on the nature of the goods and the percentage
of the total price paid) to claim damages for any loss suffered.

Advantages
•Expensive items such as machinery and plant can be acquired
without huge financial investment.
•Interest charged and depreciation of the vehicle are tax
deductible
•Terms can be flexible and fixed repayments make for easy future
budgeting.
•After full payment of the hire purchase agreement, ownership of
the goods is transferred to the hirer.

Disadvantages
1. Higher prices:
The buyer has to pay much higher prices than that payable on
cash purchase. The seller adds a margin to cover interest and
risk.
2. Transfer of Ownership:
The buyer does not get ownership of goods until last installment
paid. He cannot sell the goods before final payment.
3. Risk of bad debts:
When the buyer fails to pay installments, the seller may suffer
loss. He may have to spend money and time to recover goods
from the buyer.
4. Large investment:
The hire purchase seller has to invest considerable funds because
payments are received from buyers over a long period of time.

DIFFERENCE BETWEEN
HIRE PURCHASE AND LEASING
77

OWNERSHIP
LEASING
• In lease, ownership lies with the
lesser. The lessee has the right to
use the equipment and does not
have an option to purchase.
• Leasing is a method of financing
business assets only.
HIRE PURCHASE
• In hire purchase, the hirer has the
option to purchase. The hirer
becomes the owner of the
asset/equipment immediately after
the last installment is paid.
• Hire Purchase is a method of
financing both business assets and
consumer articles.
78
METHOD OF FINANCING

DEPRECIATION
LEASING
• In Leasing, depreciation and
investment allowance cannot be
claimed by the Lesser.
• The entire lease rental is tax
deductible expense.
HIRE PURCHASE
• In Hire Purchase depreciation and
investment allowance can be claimed
by the Hirer.
• Only the interest components of the
Hire Purchase installment are tax
deductible.
79
TAX BENEFITS

SALVAGE VALUE
LEASING
• The lessee, not being the owner of
the assets and does not enjoy the
salvage value of the assets.
• In Leasing the Lessee is not required
to make any deposit.
HIRE PURCHASE
• The hirer, in purchase being the
owner of assets and enjoy the
salvage value of the assets.
• In Hire Purchase, the Hirer is
required to deposit 20% of the cost.
80
DEPOSIT

RENT-PURCHASE
LEASING
• In Leasing, the Lessee take the asset
on a rent basis.
• Lease financing is invariably 100%
financing. It does not required any
immediate down payment or margin
money by the Lessee.
HIRE PURCHASE
• In Hire Purchase the asset is
purchased by the Hirer.
• In Hire Purchase, a margin equal to
20-25% of the cost of the assets to be
paid the Hirer.
81
EXTENT OF FINANCE

MAINTENANCE
LEASING
• In Leasing, the maintenance of
leased asset is the responsibility of
the Lessee.
• The leased assets are shown by way
of footnote only.
HIRE PURCHASE
• In Hire Purchase, the cost of
maintenance of hired assets is to be
borne by the Hirer himself.
• The assets on hire purchase is shown
in the balance sheet of the Hire.
82
REPORTING

PROSPECTS
• Leasing today accounts for 6% of total capital investment in India.
• The 8th plan envisages capital formation of `8000 billion, 50% of which is to take
place in the private sector.
• Leasing will play a significant role to account for at least 15% of gross capital
formation
• The infrastructure financing is very crucial for economic development and it can’t be
accelerated without leasing industry.
83

FACTORING AND FORFAITING
Factoring is of recent origin in Indian Context.
Kalyana Sundaram Committee recommended
introduction of factoring in 1989.
Banking Regulation Act, 1949, was amended in 1991
for Banks setting up factoring services.
SBI/Canara Bank have set up their Factoring
Subsidiaries:-
SBI Factors Ltd., (April, 1991)
CanBank Factors Ltd., (August, 1991).
RBI has permitted Banks to undertake factoring
services through subsidiaries.

WHAT IS FACTORING ?
Factoring is the Sale of Book Debts by a firm (Client) to a financial institution
(Factor) on the understanding that the Factor will pay for the Book Debts as
and when they are collected or on a guaranteed payment date. Normally, the
Factor makes a part payment (usually upto 80%) immediately after the debts
are purchased thereby providing immediate liquidity to the Client.
PROCESS OF FACTORING
CLIENT CUSTOMER
FACTOR

So, a Factor is,
a) A Financial Intermediary
b) That buys invoices of a manufacturer or a trader,
at a discount, and
c) Takes responsibility for collection of payments.
The parties involved in the factoring transaction are:-
a) Supplier or Seller (Client)
b) Buyer or Debtor (Customer)
c) Financial Intermediary (Factor)

PROCESS INVOLVED IN
FACTORING
• Client concludes a credit sale with a customer.
• Client sells the customer’s account to the Factor and notifies the
customer.
• Factor makes part payment (advance) against account purchased,
after adjusting for commission and interest on the advance.
• Factor maintains the customer’s account and follows up for payment.
• Customer remits the amount due to the Factor.
• Factor makes the final payment to the Client when the account is
collected or on the guaranteed payment date.

CHARGES FOR FACTORING
SERVICES
• Factor charges Commission (as a flat percentage of value of
Debts purchased) (0.50% to 1.50%)
• Commission is collected up-front.
• For making immediate part payment, interest charged.
Interest is higher than rate of interest charged on Working
Capital Finance by Banks.
• If interest is charged up-front, it is called discount.

TYPES OF FACTORING
 Recourse Factoring
 Non-recourse Factoring
 Maturity Factoring
 Cross-border Factoring

RECOURSE FACTORING
Upto 75% to 85% of the Invoice Receivable is factored.
Interest is charged from the date of advance to the date of
collection.
Factor purchases Receivables on the condition that loss arising on
account of non-recovery will be borne by the Client.
Credit Risk is with the Client.
Factor does not participate in the credit sanction process.
In India, factoring is done with recourse.

NON-RECOURSE FACTORING
Factor purchases Receivables on the condition that the Factor
has no recourse to the Client, if the debt turns out to be non-
recoverable.
Credit risk is with the Factor.
Higher commission is charged.
Factor participates in credit sanction process and approves
credit limit given by the Client to the Customer.
In USA/UK, factoring is commonly done without recourse.

MATURITY FACTORING
Factor does not make any advance payment to the Client.
Pays on guaranteed payment date or on collection of
Receivables.
Guaranteed payment date is usually fixed taking into account
previous collection experience of the Client.
Nominal Commission is charged.
No risk to Factor.

CROSS - BORDER FACTORING
It is similar to domestic factoring except that there are four parties,
viz.,
a) Exporter,
b) Export Factor,
c) Import Factor, and
d) Importer.
It is also called two-factor system of factoring.
Exporter (Client) enters into factoring arrangement with Export Factor
in his country and assigns to him export receivables.
Export Factor enters into arrangement with Import Factor and has
arrangement for credit evaluation & collection of payment for an agreed
fee.
Notation is made on the invoice that importer has to make payment to
the Import Factor.
Import Factor collects payment and remits to Export Factor who passes
on the proceeds to the Exporter after adjusting his advance, if any.
Where foreign currency is involved, Factor covers exchange risk also.

STATUTES APPLICABLE TO
FACTORING
• Factoring transactions in India are governed by the following
Acts:-
a) Indian Contract Act
b) Sale of Goods Act
c) Transfer of Property Act
d) Banking Regulation Act.
e) Foreign Exchange Regulation Act.

WHY FACTORING HAS NOT
BECOME POPULAR IN INDIA
• Banks’ reluctance to provide factoring services
• Bank’s resistance to issue Letter of Disclaimer (Letter of
Disclaimer is mandatory as per RBI Guidelines).
• Problems in recovery.
• Factoring requires assignment of debt which attracts Stamp
Duty.
• Cost of transaction becomes high.

Impact on Balance Sheet
• Factoring, as a financial service has a positive impact on the
Balance Sheet as can be illustrated with the help of an
example:
• Balance Sheet: Pre-factoring Position
Current Liabilities (CL) Amount Current Assets (CA) Amount
Bank borrowing against Inventory 100
i. Inventory 70 Receivables 80
ii. Receivables 50 120 Other current assets 20
Other current liabilities 30
Total 150
Net Working Capital (CA-CL) 50
Total 200 Total 200

• Original Current Ratio 1.33: 1 (200 : 150)
• Assume the borrower decides to factor his debts. The
Receivables aggregating Rs. 80 crore are purchased by a factor
who in turn makes advance payment of 80% i.e. Rs. 64 crore. He
retains Rs. 16 crore (factor reserve) which will be repaid on
payment by the customer.
• Impact of factoring on balance sheet
• Reduction in Current Liabilities. An advance payment of Rs. 64
crores (i.e. 80% of 80 crore) is utilised in repaying the bank
borrowings against receivables to the tune of Rs. 50 crores and
for meeting other current liabilities to the tune of Rs. 14 crores.
The net effect of factoring transaction is that the current
liabilities get reduced by Rs. 64 crore
• Improvement in Current Ratio. The current ratio improves from
1.33: 1 (before factoring) to 1.58 : 1. The new current ratio is
better for the client and his credit rating goes up before public
eye.

FORFAITING
“Forfait” is derived from French word ‘A Forfait’ which
means surrender of fights.
Forefaiting is a mechanism by which the right for
export receivables of an exporter (Client) is purchased
by a Financial Intermediary (Forfaiter) without recourse
to him.
It is different from International Factoring in as much
as it deals with receivables relating to deferred payment
exports, while Factoring deals with short term
receivables.

FORFAITING (contd…)
• Exporter under Forfaiting surrenders his right for claiming payment
for services rendered or goods supplied to Importer in favour of
Forefaiter.
• Bank (Forefaiter) assumes default risk possessed by the Importer.
• Credit Sale gets converted as Cash Sale.
• Forfaiting is arrangement without recourse to the Exporter (seller)
• Operated on fixed rate basis (discount)
• Finance available upto 100% of value (unlike in Factoring)
• Introduced in the country in 1992.

MECHANICS OF FORFAITING
EXPORTER IMPORTER
FORFAITER AVALLING BANK
HELD TILL MATURITY
SELL TO GROUPS OF INVESTORS
TRADE IN SECONDARY MARKET

ESSENTIAL REQUISITES OF
FORFAITING TRANSACTIONS
• Exporter to extend credit to Customers for periods above 6
months.
• Exporter to raise Bill of Exchange covering deferred receivables
from 6 months to 5 years.
• Repayment of debts will have to be avallised or guaranteed by
another Bank, unless the Exporter is a Government Agency or a
Multi National Company.
• Co-acceptance acts as the yard stick for the Forefaiter to credit
quality and marketability of instruments accepted.

IN FORFAITING:-
Promissory notes are sent for avalling to the Importer’s Bank.
Avalled notes are returned to the Importer.
Avalled notes sent to Exporter.
Avalled notes sold at a discount to a Forefaiter on a NON-
RECOURSE basis.
Exporter obtains finance.
Forfaiter holds the notes till maturity or securitises these notes
and sells the Short Term Paper either to a group of investors or
to investors at large in the secondary market.

COSTS INVOLVED IN
FORFAITING
• Commitment Fee:- Payable to Forfaiter by Exporter in consideration
of forefaiting services.
• Commission:- Ranges from 0.5% to 1.5% per annum.
• Discount Fee:- Discount rate based on LIBOR for the period
concerned.
• Documentation Fee:- where elaborate legal formalities are involved.
• Service Charges:- payable to Exim Bank.

FACTORING vs. FORFAITING
POINTS OF
DIFFERENCE
FACTORING FORFAITING
Extent of Finance Usually 75 – 80% of the
value of the invoice
100% of Invoice value
Credit
Worthiness
Factor does the credit
rating in case of non-
recourse factoring
transaction
The Forfaiting Bank
relies on the
creditability of the
Avalling Bank.
Services provided Day-to-day administration
of sales and other allied
services
No services are
provided
Recourse With or without recourse Always without
recourse
Sales By Turnover By Bills

COMPARATIVE ANALYSIS
BILLS
DISCOUNTED
FACTORING FORFAITING
1. Scrutiny Individual Sale
Transaction
Service of Sale
Transaction
Individual Sale
Transaction
2. Extent of
Finance
Upto 75 – 80% Upto 80% Upto 100%
3. Recourse With Recourse With or
Without
Recourse
Without
Recourse
4. Sales
Administration
Not Done Done Not Done
5. Term Short Term Short Term Medium Term
6. Charge
Creation
Hypothecation Assignment Assignment

VENTURE CAPITAL• Venture capital (VC)
is financial
capital provided to early-
stage, high-potential,
high risk, growth startup
companies. In broad
terms, venture capital is
the investment of long
term equity finance
where the venture
capitalist earns his
return primarily In the
form of capital gains.

Venture Capital Fund
• Venture capital means funds made available for startup firm and small
businesses with exceptional growth potential.
• The SEBI has defined Venture Capital Fund in its Regulation 1996 as ‘a
fund established in the form of a company or trust which raises money
through loans, donations, issue of securities or units as the case may be
and proposes to make investments in accordance with the regulations’.

CHARACTERISTICS OF VENTURE CAPITAL
• Illiquidity: Easy liquidity by cashing out in short-term is
not an option for venture capital funding.
• Long-term commitment: Venture capital financing is a
long term, illiquid investment, it is not repayable on
demand.
• Equity participation: Venture capital is actual or
potential equity participation through direct purchase of
shares, options or convertible securities. The objective is
to make capital gains by selling-off the investment, once
the enterprise becomes profitable.
• Participation in management: Venture financing ensures
continuing participation of the venture capitalist in the
management of the entrepreneur’s business.

PROCESS OF VENTURE CAPITAL
FINANCING
• Deal Origination.
• Screening.
• Due diligence.
• Preliminary evaluation
• Detailed evaluation
• Deal Structuring.
• Post-investment Activity.
• Exit plan.

FINANCING
DEAL ORIGINATION
R
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Intermediaries
Active
Search

FINANCING
• SCREENING

FINANCING

FINANCING
RISK
ANALYSIS

FINANCING
• PRODUCT RISK
• MARKET RISK
• TECHNOLOGICAL RISK
• ENTREPRENEURIAL RISK

FINANCING
• DEAL STRUCTURING

FINANCING
• POST INVESTMENT ACTIVITIES

METHODS OF VENTURE FINANCING
• EQUITY
When a venture capitalist contributes equity capital,
he acquires the status of an owner and becomes
entitled to share in the firm’s profits as much as he is
liable for losses.

• CONDITIONAL LOAN
A conditional loan is repayable in the form of a
royalty after the venture is able to generate sales.
In India VCF’s charge 2-15% royalty.

• INCOME NOTE
It is a hybrid security which combines the features
of both conventional and conditional loan. The
entrepreneur has to pay both interest and royalty on
sales but at low rates.

Venture Capital Funds Set Up during 1987-1994
*top 5(capital based)
VC Fund Set Up By Year Size million
Venture Capital
Unit Scheme II
TDICI 1990 RS 1000
Venture Capital
Fund Scheme
IDBI 1987 RS 543.6
IL&FS Venture
Fund
IL&FS Venture
Corporation Ltd
1991 RS 500
Venture Capital
Unit Scheme I
TDICI 1989 RS 300
Venture Capital
Unit Scheme III
RC&TF Corporation 1991 RS 300

Venture Capital Funds in India
VCFs in India can be categorized into following five groups:
Those promoted by the Central Government controlled development
finance institutions. For example:
• ICICI Venture Funds Ltd.
• IFCI Venture Capital Funds Ltd (IVCF)
• SIDBI Venture Capital Ltd (SVCL)
Those promoted by State Government controlled development finance
institutions.
• Punjab Infotech Venture Fund
• Gujarat Venture Finance Ltd (GVFL)
• Kerala Venture Capital Fund Pvt Ltd.

CONT…
Those promoted by public banks.
• Canbank Venture Capital Fund
• SBI Capital Market Ltd
Those promoted by private sector companies.
• IL&FS Trust Company Ltd.
• Infinity Venture India Fund.
Those established as an overseas venture capital fund
• Walden International Investment Group
• HSBC Private Equity.

Rules & Regulations for VC in India
AS PER SEBI:
VCF are regulated by the SEBI (Venture Capital Fund) Regulations, 1996:
The following are the various provisions:
• A venture capital fund may be set up by a company or a trust, after a
certificate of registration is granted by SEBI. On receipt of the certificate of
registration, it shall be binding on the venture capital fund by the provisions of
the SEBI Act.
• A VCF may raise money from any investor (Indian, NRI or foreign) provided
the money accepted from any investor is not less than Rs 5 lakhs. The VCF
shall not issue any document or advertisement inviting offers from the public
for subscription of its security or units

CONT….
• SEBI regulations permit investment by venture capital funds in equity or
equity related instruments of unlisted companies.
• At least 80% of the funds should be invested in venture capital companies
and no other limits are prescribed.
• A VCF is not permitted to invest in the equity shares of any company or
institutions providing financial services.
• The securities or units issued by a venture capital fund shall not be listed on
any recognized stock exchange till the expiry of 4 years from the date of
issuance .

Provisions of Income-Tax :
• The Income Tax Act provides tax exemptions to the VCFs under Section
10(23FA) subject to compliance with Income Tax Rules.
• Restrict the investment by VCFs only in the equity of unlisted companies.
• VCFs are required to hold investment for a minimum period of 3 years.
• The Income Tax Rule until now provided that VCF shall invest only up to 40%
of the paid-up capital of VCU and also not beyond 20% of the corpus of the
VC.
• After amendment VCF shall invest only upto 25% of the corpus of the
venture capital fund in a single company.
• There are sectoral restrictions under the Income Tax Guidelines which
provide that a VCF can make investment only in specified companies

INTRODUCTION
• The Hon’ble Prime Minister of India, while presenting the Union Budget for
1987-88 on February 28, 1987 announced the decision to establish the
National Housing Bank (NHB) as an apex level institution for housing
finance.
• National Housing Bank Bill (91 of 1987) providing the legislative framework
for the establishment of NHB was passed by Parliament in the winter session
of 1987
• In pursuance of the above, NHB was set up on July 9, 1988 under the
National Housing Bank Act, 1987.
• NHB is wholly owned by Reserve Bank of India, which contributed the entire
paid-up capital.

OBJECTIVE OF STUDY
• NHB has been established to achieve, inter alia, the following
objectives –
• To promote a sound, healthy, viable and cost effective housing finance
system to cater to all segments of the population and to integrate the
housing finance system with the overall financial system.
• To promote a network of dedicated housing finance institutions to
adequately serve various regions and different income groups.
• To augment resources for the sector and channelise them for housing.
• To make housing credit more affordable.
• To regulate the activities of housing finance companies based on
regulatory and supervisory authority derived under the Act.
• To encourage supply of buildable land and also building materials for
housing and to upgrade the housing stock in the country.
• To encourage public agencies to emerge as facilitators and suppliers of
serviced land, for housing.

Source of finance
• DIRECT HOUSING FINANCE
• Direct Housing Finance refers to the finance provided to
individuals or groups of individuals including co-operative
societies.
• INDIRECT HOUSING FINANCE
• Banks should ensure that their indirect housing finance is by
way of term loans to housing finance institutions, housing
boards, other public housing agencies, etc

HOUSING LOANS UNDER PRIORITY
SECTOR
The following housing finance limits will be considered as
Priority Sector Advances:
1. Direct Finance
(i) Loans up to Rs. 15 lakh in rural, semi-urban, urban and
metropolitan areas for construction of houses by individuals,
with the approval of their Boards.
(ii) Loans up to Rs.1 lakh in rural and semi urban areas and
Rs. 2 lakhs in urban areas for repairs to damaged houses by
individuals.

2 Indirect Finance
• (i) Assistance given to any governmental agency for
construction of houses, or for slum clearance and
rehabilitation of slum dwellers, subject to a ceiling of Rs. 5
lakh of loan amount per housing unit.
(ii) Assistance given to a non-governmental agency approved
by the National Housing Bank for the purpose of refinance
for reconstruction of houses or for slum clearance and
rehabilitation of slum dwellers, subject to a ceiling of Rs. 5
lakh of loan amount per housing unit.

HDFC HOUSING FINANCE SERVICES
• Home Loan
• Home Improvement Loan
• Home Extension Loans
• Land Purchase Loans
• Top – Up Loans

LIC HOUSING FINANCE SERVICES
• Purchase of flats/house
• Construction
• Extension of flats/house
• Plot purchase
• Repairs/renovation to existing flats/house

SBI HOUSING FINANCE SERVICES
• SBI Surakshit Home Loan
• SBI Yuva Home Loan
• SBI Home Loan PAL ( Pre-Approved Limit )
• SBI Maxgain (Home Loan as an overdraft)
• SBI Realty
• NRI Home Loans
• Gram Niwas

Performance of 57 HFCs in FY 2012-13
Parameters Housing
Loans
Other Loans Total
Loans Sanctioned 40314 17564 57878
Loans Disbursed 32713 12650 45362
Loans Outstanding
(As on March 31,2013) 2,85,711 1,01,333 3,87,044
Housings loans as percentage
to total loans and advances 73.81%
GNPA percentage as a total of
loan outstanding
1.09 %
Amount in crore

NHB – Performance Highlights :2012-
13 (upto 31st March 2013)
 Cumulative Refinance Disbursements crossed Rs. 1 lakh crore
 Disbursed Rs. 15750 crore under its various refinance schemes in FY
2012-13. Of this, Rural areas accounted for 43% and loans below Rs. 15
lakh accounted for 75.63%.
 A total of Rs. 4000 crore has been allotted under RHF in FY 2012-13 of
which Rs. 3224.62 crore have been disbursed upto 31st March 2013
covering more than 1 lakh housing units.
 Under its Housing Micro Finance (HMF) programme, 40210 housing units
located both in urban and rural areas have been financed through MFIs.

NHB – Performance Highlights…Contd.
 NHB, as a Central Nodal Agency for ISHUP, a scheme of MoHUPA, has
disbursed subsidy claims amounting to Rs. 7.85 crore covering 8885
beneficiaries across 8 states
 In 2012-13, NHB as a Nodal Agency for 1 % Interest Subvention Scheme , has
disbursed Rs.380 crore upto 31st Mar, 2013 to banks & HFCs
 NHB will be managing the CRGFTLIH set up by MoHUPA, GOI and GRGFS
as notified by GOI. 31 MLIs have signed MoU.
 For the benefit and use of all stake holders of the housing industry, NHB has
been releasing Residential Price Index known as NHB-Residex since 2007. The
Index is released on quarterly basis and now covers 26 cities. The latest Index
released is for January-March 2013.

Refinance Disbursements by NHB in
FY 2012-13 (as on 31-3- 2013)
Institution Category Regular
Scheme
RHF GJRHRS Total
Housing Finance Companies 2900 1302 1865 6067
Scheduled Commercial Banks 6007 1802 1650 9459
Regional Rural Banks 103 120 - 223
Cooperative Sector - - - -
Total 9010 3224 3515 15749
 42.79 % of the total disbursement was towards RHF and GJRHFS
Amount in crore

Golden Jubilee Rural Housing Finance Scheme (GJRHFS)
 NHB Roles:
1. Monitoring of the scheme by setting annual targets and
encouraging the PLIs to fund under the scheme
2. Sending information to the GoI on the scheme status and updates
 Status Update for the FY 2012-13 (April 2012 - March 2013) : Total
achievement has been 4,18,784 units against a target of 4,00,000 units i.e.
achievement of 105 %
 Target allocated for FY 2012-13: 4,50,000 units to Banks, HFCs and RRBs
Target vs Achievement 2012-13
Institution April 2012 – March 2013 Percentage Achievement
vis-à-vis targetTarget Achievement
No. of units No. of units
Housing
Finance
Companies
1, 40,000 2,02,941 145%
PSB’s & RRBs 2, 60,000 2,15,963 83 %
TOTAL 4,00,000 4,18,784 105 %

Recent Developments in Housing Sector
 Focus on Affordable Housing for Low Income and Rural Housing
 Focus on Energy Efficient homes
 Setting up of Central Registry of Securitization Asset Reconstruction and
Security Interest of India (CERSAI) , Credit Risk Guarantee Fund Trust for
Low Income Housing (CRGFTLIH) and India Mortgage Guarantee
Company Pvt Ltd (IMGC)
 Increase in the number of cities under NHB’s RESIDEX, now covering 26
cities
 Allowing External Commercial Borrowings (ECBs) for low-cost affordable
housing projects by HFCs and builders
144

 Formulation of draft Real Estate Regulation & Development Bill Formulated
 Tailor made products like RML and RMLeA for senior citizens
 Introduction of Long Term Fixed Rate Mortgages for low income segments
 Initiation of Housing Start Up Index by RBI in collaboration with MoHUPA
 Dhanendra Kumar Committee recommending setting up of a technology-
enabled single-window portal for streamlining the process of approvals for
real estate projects
 Release of Report on Housing Stock, Amenities and Assets in Slums Based
on House listing & House Census- 2011
 Release of Technical Committee report on Housing requirements in Urban
areas during the 12th Five Year Plan by MoHUPA.
Recent Developments…Contd.

Union Budget - 2013-14
for Housing Sector
 Interest deduction up to 1.00 lakh for new home
loans up to 25.00 lakh
 Setting up of Urban Housing Bank Fund with initial
corpus of 2,000 crore
 Increase in RHF to 6,000 crore
 Securitization Trusts exempted from Income Tax
 Existing exemptions from service tax for low cost
housing and single residential units to continue

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