The organization and implementation of leasing operations

THE ORGANIZATION AND IMPLEMENTATION OF LEASING OPERATIONS

1. The leasing contract

The specialty literature considers the leasing contract as an atypical contract, being situated somewhere in between renting, buying, and crediting, but in no case must it be seen as a combination of those contracts. It is qualified as a "sui generis" contract, and it is based on the following principles: [1]

leasing is a special form of financing for the ceding of using the leasing object;

the leasing contract, in general, is not a type of contract specially authorized by the Civil Code;

through the leasing contract, special triangular relationships are constituted between leasing supplier-the lessor-the user;

regarding the delimitation of risks in leasing affairs between the lessor and the user are specified clauses of these contracts.

In specialty literature there is also a bifunctional theory of "sui generis" character, which consists of the fact that there are two functions equally important[2]:

the function of ceding the usage of the leasing contract;

the function of financing the leasing affairs on the validity of the leasing contracts.

From a juridical point of view, the contract has the following characteristics:[3]

it is a bilateral juridical act, between the leasing company as a lessor, and the user, as the beneficiary;

it is a sinalagmatic act, because both parties oblige themselves mutually;

it has an onerous title and a patrimonial content, meaning that the transmission of the usage right is made in exchange of a cost;

it is a non-transmittable ownership act, meaning it only transmits the usage right, not the property right;

it has a consensual character, it is sufficient the expression of will of the parties;

it has a complex character;

it has an intuitu personae, that means that the user must provide the evidence of the future exploitation of the good;

it is a successive executing contract, its effects are seen throughout the complete duration of the contract.

Usually in the case of financial leasing, there is no possibility of a cancelation of the contract from the behalf of the user. So, he is obliged to pay all the royalties regardless of the circumstances[4].

The classification of leasing contracts[5].

1. According to the quality of the user:

public, the one whose beneficiary is the state;

private, when a private company is being financed.

2. According to the belonging of the parties:

national leasing contract -if the parties belong to a single state;

international leasing contract - when a foreign element intervenes.

3. According to the calculation of the installments:

full -pay-out leasing contract, with complete amortization;

non-full-pay-out-leasing-contract, with partial amortization.

4. According to the belonging of the invested funds through the leasing contracts:

leasing accomplished with the funds of a single leasing company;

unionized leasing with funds belonging to several leasing companies. Law nr. 51/1997 authorizes unionized leasing in art. 23.

5. According to the provenience of the financed goods:

classical leasing contracts, with a three-party structure;

leasing contracts which has as an object a good in the lessor's patrimony or even built by the lessor.

lease-back contract, where the used good is sold to the leasing company by the beneficiary himself.

6. According to the nature of the contracted good

movable leasing contracts;

immovable leasing contracts.

7. According to the nature of the leasing operation:

financial leasing contract: the lessor and the lessee establish the duration of the non-cancelable leasing-contract.The risks of investing and valuing of the leasing object at residual value go in general to the user, according to the forms of the contract and its clauses. The financial leasing contracts can be grouped into three categories[6]: (appendix 1.)

a)     fully amortized contracts:

leasing contract without option right;

leasing contract with a buying option;

leasing contract with an option of delaying the rental duration.

b)     partially amortized contracts:

partially amortized contracts with the right of servitude of the leasing user;

partially amortized contracts with the right of sharing the supplementary revenue;

c)      special financial leasing contracts:

This category of contracts comprises the leasing business in which the leasing object is designed for a single user.

operational leasing contract: it is seen as an independent category and with other juridical and fiscal consequences. The operational leasing contracts are short-term agreements akin to a rental of property[7]. The parties have the right of canceling the contract.

According to the specialty literature the leasing contract must comprise at least the following minimal elements[8]:

- the denomination and technical description of the object of the contract;

- the date and place of the reception of the good and the exploitation instructions;

- delivery conditions of the good, establishment of the expenses and risks;

- usage, maintenance and control of the leased good and the lessee's obligations;

- warrantee of the good, with implications and the way of exercising the ownership right;

- cancellation of the contract for different cases and its implications;

- expiration of the contract, according to the simple option of the lessee;

- the shape of the returned good;

- the period of usage of the good by the user;

- the estimative price of the good;

- the value of the installment and the date when the user will pay it to the lessor;

- the manner of solutioning eventual litigations.

According to the Romanian law, the leasing contract must comprise at least the following elements:[9]

the parties: the lessor and the lessee;

the exact description of the good which is the object of the contract;

the total value of the leasing contract;

the value of the leasing installments and the deadline for paying them;

the usage period;

the clause according the obligation of insuring the good.

The accounting treatment of leasing operations

Lucrare: Motivatia si satisfctia in munca -premisele reusitei si succesului profesional Lucrare: Procesul asigurarea calitatii - tratarea produsului neconform

The obligation of including the leasing object in the balance sheet does not depend on the type, size, or value of the leasing object, but on the character of the leasing contract, which authorizes the accounting and balance-sheet treatment, as well as tax obligations of the parties.

The important factor in establishing the obligativity of the parties in registering the leasing object in the balance-sheet is determined from a financial and fiscal point of view by the assignment of the economic property to the lessor, or to the user. In leasing businesses, there are two types of property relationships:

juridical property

economic property

The economic property is a complicated term and it has different interpretations in the juridical systems of some states. In Germany, for example, the fiscal law established this kind of property, which was then taken by the commercial law. In the specialty literature, the economic owner is that party which uses economic goods based on the following criteria:

it serves entrepreneurial purpose

at the end it will be paid by the entrepreneur

the user carries the risk of its integrity

The main arguments which can determine the criteria of assignment of the economic property are the following:

the leasing contracts, from an accounting and fiscal point of view, will be appreciated according to the economic considerations;

if the economic goods (the leasing object), will be attributed to the ownership of the lessor or to the user, it will be officially appreciated according to the circumstances of the singular cases;

in financial leasing, the assignment of the economic property is made, generally, according to the duration of rental established in the leasing contract, officially specified on categories and types of leasing contracts.

Through the establishment of the economic property of the leasing object, the party which is assigned to it, according to fiscal and commercial legislation, has the following accounting and fiscal obligations:

to register the leasing object in the accounting (accounting obligations);

to emphasize in his own balance-sheet the leasing object (balance sheet obligation);

to administer from a tax point of view the leasing object (fiscal obligation).

In Germany, for instance, as well as in the other west-European countries with tradition in leasing operations, in the accounting evidence of leasing operations, there are special accounts for leasing, such as: the account for registering the leasing installments in user accounting, is called "rental leasing", and in the accounting of the lessor, it is called "income from leasing businesses".

With the purpose of establishing the character of economic owner, as well as the accounting procedures of leasing operations, a practical example, using the accounting method and form used in Germany, will be presented in appendix 2[10].

Regarding Romania, the first accounting reglementations of leasing operations were made through OMF nr. 686/1999. Through this, the first steps towards the application of the importance of the economic above the juridical[11].

After that, the norms were annulled and replaced with OMFP nr. 306/2002, harmonized with the European Directives, which were applied by small and medium enterprises, as well as by the microenterprises. The big companies were applying OMFP nr. 94/2001, which has also brought an upgrading in the sense of harmonizing with IAS 17"Leasing"

These were also annulled in the moment of entering into force of the decree nr. 1752/2005, which brought as a novelty the following :" in the case of the entities which have as a main object of activity - leasing-, in the net turnover the interest related to these contracts is included, according to the reporting period"[12].

The last one mentioned above was also modified, through the Decree nr. 2374/2007, for approving the accounting reglementations according to the European Directives.

Following the dynamic of the legislation regarding leasing activities, an attempt of harmonizing the Romanian legislation with IAS 17 can be noticed.

For better understanding of the accounting treatment of leasing operations in Romania, the accounting registration according to the Romanian account, the main accounting procedures registered by the lessor, and by the lessee will be presented in appendix 3.

3. Procedures of fundamenting the financing decision of leasing operations

The calculation method for financial leasing installments differs from one form of leasing to another and from one leasing company to another. Usually, determining their size is done according to a series of elements considered "the minimum":

1. the acquisition price of the good or the value of the financing represents the determining factor, which will appear constantly in the structure of the leasing installments;
2. the duration of the tenancy representing the term for which the lessee contracted the good and during which the lessor will recover the majority of his financial leasing investment;
3. the "depreciation" quantum  of the object of leasing;
4. the residual value represent the market value of the good at the end of the financial leasing term, this is also the concept of IAS 17.[13] Specialized literature considers that, in conformity with the theoretical and practical principles, the minimum level of the residual value in leasing contracts is set some where around the value of 20%;
5. The advance granted by the tenant acts in the favor of the lessor's financial situation;
6. The lessor's profit, represented by the interest of the financial leasing which applies to the value of financing and covers the interest paid by the financer to the bank or to other creditors.

Beside these minimal elements, the leasing installment can also have, according to the case, one or more of the additional elements listed below :

1. costs from acquiring the good will appear distinctly in the structure of  the capital expenses or as an administration tax (leasing tax);
2. expenses for the maintenance and repair services( respectively insuring expenses) of the good;
3. the value of the leasing contract's  cancellation clause. This is available especially for operational leasing , but in some cases, the lessee can request such a clause in the financial leasing contract[14];
4. expenses for finding a user or buyer;
5. the depreciation rate of the currency that was used when to establish the value of the leasing installments.

Regarding the additional influential elements in forming the leasing installment in Romania, these are represented by at least the following:

1.     the administration commission or leasing tax is variable ( between 0.5% and 5%), with rare exceptions being over 5% of the price of acquisition for the good;

2.     the VAT paid by the financer when acquiring the good and recovered through the VAT quotations afferent to the leasing installments[15];

3.     unforeseen expenses  represent a maximum of 5% of the financing value;

4.     the custom duty is included in the value of the royalty if the good is imported. 

Consider a leasing company that accepts to finance the acquisition of a good ( auto vehicle ) for which the acquisition price in CIP delivery conditions is of  acquisition price euro.

The contracting conditions presented in the financial leasing offer are the following :

residual value - Pvr%

amount paid in advance - Pav%

administration commission - Cg%

leasing company interest - D1%

duration of the lease - h months

The notations are the following:

= the user contribution to financing and it represents the advance perceived by the leasing company to the user when the contract is signed :

= Financed value, it represents the sum which the leasing company borrowed from the bank for the acquisition of the good, it is in fact the difference between the acquisition price of the good (CIP price ) and the value of the advance cashed from the user :

= residual value: it represents the sum which must be paid by the user at the end of the financial leasing contract in order to obtain the ownership right of the good.

In the case of financial leasing the leasing installment is calculated like a constant annuity.

The calculation formula is given by the following relationship:

The leasing installment  =

Where:   = annuity factor

The annuity factor represents the present value of one monetary unit spent or obtained annually, for h months

H= the total number of periods of time when the leasing installment is calculated and paid. This represents the duration of the leasing contract

A= actualization coefficient which includes the interest perceived by the leasing company to the user (D1)

Thus, we can state that the leasing installment is equal to the sum between the principal and the interest. The principal is the monthly value perceived by the leasing company, to the user, to which interest is applied.

For the use, the principal is made of the depreciation of the good, and the remaining represents a non-deductible expense.

The system of calculation the interest is a digressive one, and it is calculated by multiplying the interest rate with the remaining value from the beginning of the month.

For better understanding the components of the leasing installment, a case study will be presented in appendix 4.

In the case of operational leasing, the calculation of the operational leasing installments is made by applying the same methodology, the only difference is that the residual value is not taken into account.

The leasing installment (annuity) =  ( appendix 5.)

The coefficient "a" is in fact the interest rate according to which the interest perceived by the leasing company to the user is established.

In case of the operational leasing, the leasing  installment consists of:

a)     depreciation

b)     the profit margin

The amortization is registered in the accounting of the leasing company, while the user registers the installments in the Romanian account 8036 - "Redevente, locatii de gestiune, chirie si alte datorii assimilate"[16].

The profit margin is the difference between the value of the royalty and the monthly amortization. This represents the gross profit for the leasing installments.

4. Management of risk in leasing operations.

The categories of risks to which the lessors are submitted are diverse, and can be grouped in the following categories[17]:

1. Risks with a general character, also called credit risks:

a)     risks of credit worthiness - appear as a consequence of engaging in credits for financing a leasing operation

b)     risks with the modification of the interests - appear when the clauses of the contract don't refer to actualization of the leasing interest

2. Risks specific to leasing, which results from the specific character of this activity:

a)     risks regarding the leasing object - can be the risk of partial damage or total damage, or theft risk, risk of liquidity determined by the incapacity of payment on behalf of the user, risk regarding the residual value of the leasing object

b)     risks regarding the leasing contract - risk concerning the warrantee of the object, risks regarding the environment, risk regarding the possibility of ending the contract.

3. Other types of risks[18]:

portfolio risks ( caused by the uneven distribution of the leasing contracts)

exchange-rate risks ( it is in fact a risk of a speculating nature)

risks regarding taxes and legislation (regarding the state's fiscal policy)

There are several methods through which a leasing company can protect the leasing company against the risks, such as:

1. analyzing the credit worthiness of the client (selecting the clients according to their payment capacity)
2. ensuring the leasing object ( it can be done for covering at least the following categories of risks: general risks and major force causes, risks having a technological and management character, risks having a financial character)
3. constituting  provisions which have the following forms:

provisions for covering the credit worthiness risk

provisions for covering the risks regarding the payment of the interests

provisions for covering the risks related to the leasing object

provisions for risks regarding the realization of the leasing contract.

As for the lessee, the types of risks can be grouped as follows:

1. risks with general character, such as the risk with the modification of the interest.
2. risks regarding the leasing activity such as:

a)     risks regarding the leasing object which especially refers to the risk related to the residual value of the leasing object

b)     risks implied by the realization of the contract referring to:

risks regarding the leasing contracts without a cancellation clause (onerous contracts);

risks regarding the damage of the object;

risks regarding the misinterpretation of the leasing contract;

risks involving the protection of the environment.

There are several methods of identification and analysis of risk such as the following: the risk inspection, the interview, the questionnaire, the analysis of the financial documents, the analysis of the flows diagram and evaluation of damage portfolio.

There are three main methods through which the companies organize management of risk:

a)     Insurances Compartment (under the direct leadership of the Financial Director)

b)     the management of risk compartment

c)      the management of risk committee 

On the short-term, the following aspects will be approached:

identification and evaluation of risk exposures of the company

control of the risks;

adopting a strategy of ensuring and managing the Ensurance Program;

the management of compensation;

implementing an information system for handling risks;

conceiving a manual for procedures of management of risk.

On the medium term, these functions will extend their influence upon the general activity of the company, offering support for evaluation of the general risk of the activity, also called business risk.

In the compartment for risk management, the staff should include four persons:

the risk manager;

the damage specialist;

the risk control specialist;

an administrator of data network.