The concept of leasing can be understood by comparing the lease to the purchase of a specific asset. If a firm wishes to obtain the service of a specific asset, it has two alternatives: Purchase or Lease. To purchase the asset, the firm must payout a lump sum or agrees to some type of installment plan that involves incurring a long term liability. Leasing the assets, on the other hand, provides the firm with asset’s services without necessarily incurring any capital liability. Leasing is a source of financing as it enables the firm to obtain the use of assets in exchange for agreeing to pay lease rentals.
In case of leasing, the asset is handed over by the lessor to the lessee in return for a lease rental. The ownership and the title to the assets remain with the lessor. The lessor, however, recovers the cost of the assets as well as a reasonable return in form of rental income. The lessor also gets the deduction in taxable income for the depreciation of the assets (though not using the assets). The lessee gets the opportunity of using the assets in its entirety without owning it. Further, the rental, paid by the lessee gets fully deducted from the taxable income of the lessee.
In case of hire purchase, the seller hands over the assets to the buyer but the title to goods are not transferred. The buyer becomes the owner of the goods and acquires the title to the goods only when he makes the payments of all the installments. In case of default in payment by the buyer, the seller can repossess the goods. The buyer treats the installments already paid by the buyer up to the date of repossession, in such a case, as ‘hire’ towards using the assets. The hire-purchaser shows the assets in his balance sheet and can claim depreciation from taxable income, although he may not be the owner at that time. The interest part of the installment can also be claimed as deduction from the taxable income.