The IMF's Statistical Systems in Context of Revision of the United Nations' A System of National Accounts
Chapter

26 Financial Leasing

Author(s):
Vicente Galbis
Published Date:
September 1991
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Author(s)
Brian Newson

The 1970s saw rapid growth of the practice of equipment leasing, whereby instead of industrial enterprises themselves buying the capital goods they needed, with financing by a bank loan, the banks bought the equipment and leased it to the users. In the national accounts the result was that industrial enterprises' gross fixed capital formation and borrowing went down, while their intermediate consumption and services went up substantially; at the same time, the banking sector came to carry out a significant part of total gross fixed capital formation (frequently in equipment totally unrelated to banking) but made fewer loans.

The change was totally artificial because, to both the user of the equipment and the bank, such leasing contracts are a clear substitute for the more usual bank loan. It is the user who chooses the equipment and is responsible for its maintenance, in every way acting as (although not legally being) the owner of the goods. In fact many countries' rules for company accounts have been changed so that leased goods appear in the accounts of the user.

National legislation makes leasing more or less easy, more or less attractive in different countries; but leasing is clearly a phenomenon that will remain a major method of financing capital formation, which the United Nations' A System of National Accounts (SNA) must take into account if analysis of national accounts and financial data is not to become seriously misleading.

The need for a new treatment of financial leasing has already been recognized in business accounting, industrial statistics, and the balance of payments. Leasing was discussed by the Organization for Economic Cooperation and Development's Group of Financial Statisticians as long ago as 1977, and by the OECD Working Party on Accounting Norms as recently as the summer of 1988. National accounts working parties of the OECD and the Statistical Office of the European Communities (EUROSTAT) both discussed the question in 1981, and since then several countries have implemented the new treatment. The fourth edition of the IMF's Balance of Payments Manual (BPM) recommended the new treatment in 1977, and the SNA Expert Group Meeting on the External Sector (March-April 1987) recommended that the SNA and balance of payments be aligned in their treatment of financial leasing.

This paper proposes a new treatment in the SNA of financial leasing and the capital goods obtained through financial leasing. The new treatment has repercussions throughout the whole SNA system: in the production account and input-output table, the income and outlay account, the capital finance account, and the balance sheets for both financial and nonfinancial assets. Leasing also affects the accounts of most sectors and industries.

I. Definition of Financial Leasing

A financial lease is an arrangement, for the provision of a capital good, between a lessor who provides the initial finance and a lessee who has the use of the asset without initially legally owning it. The following characteristics are typical under a financial lease arrangement.

•The capital good is selected by the lessee from lists of goods available from manufacturers or other suppliers, the purchase of the good being arranged by the lessee. The role of the lessor is simply to provide the requisite finance. The lessor does not purchase goods in advance of negotiating leases merely in the expectation that suitable lessees will appear. The initiative and the investment decision itself is therefore taken by the lessee and not the lessor. When the lessee has decided to acquire some machinery or equipment, he or she approaches the lessor in order to arrange the finance for the purchase.

•The duration of the original contract or primary lease has to be sufficiently long to enable the lessor to amortize his or her capital outlay out of the rentals and to receive an adequate return on his or her outlay. The primary lease will usually be somewhat less than the expected economic lifetime of the asset but long enough to enable the whole of the lessor's outlays to be recovered without raising the rentals to unreasonably high levels from the lessee's point of view.

•At the end of the primary lease, by which time the equipment has been fully amortized by the lessor, there are several possibilities: (1) a new lease may be negotiated at a much reduced rental; (2) the good may be sold, in which case the lessee may be entitled to receive a share, and possibly the bulk, of the proceeds as a “rebate of rentals”; or (3) the good may be sold to the lessee.

It can be seen that the combined effect of the above conditions is to make the role of the lessor purely financial. At no stage does the equipment ever come into the possession of the lessor. The lessor does not have to have any expertise whatsoever concerning the equipment and may lease many different kinds of equipment simultaneously to different lessees. It follows that any type of equipment, from street lamps to oil rigs, is suitable for financial leasing, and virtually every type of equipment is in fact leased. The passive financial role of the lessor is reinforced by the fact that it is the lessee who is responsible for the insurance and maintenance of the equipment and enjoys all the rights in relation to the supplier that arise out of normal conditions of sale.

Difference Between Financial and Operating Leasing

It is clear that financial leasing is a very different kind of activity from “operating” leasing or the temporary hiring of equipment. There are businesses that specialize in hiring by building up stocks of equipment such as automobiles, television sets, agricultural equipment, building equipment, and the like that they hire out to users for short periods of time. In contrast to financial leasing, in the case of operating leasing or hiring:

  • The equipment is purchased, maintained, and serviced by the lessor, who must therefore have considerable expertise in the type of equipment being leased

  • The equipment is usually leased to several lessees in succession for fairly short periods of time, and the lessor does not expect to amortize the equipment during the period of the first lease

  • The lessee has no residual interest whatsoever in the equipment at the end of his or her lease because the equipment is returned to the stock of equipment maintained by the lessor

  • Operating leasing is typically confined to equipment that can be moved from one location to another without too much difficulty, whereas financial leasing can cover any type of equipment.

Hire Purchase

It may be much more difficult to distinguish financial leasing from hire purchase, especially when the primary lease may give the lessee the option to purchase at the end of the lease. Fortunately, this distinction is not so important in practice because it is proposed to treat financial leasing in essentially the same way as hire purchase in the accounts.

Definition

Various definitions have been proposed to delimit financial leasing and tend to focus on one or another aspect or a combination of the aspects of financial leasing described above in order to distinguish financial leasing from other forms of financing the provision of capital goods. From a microeconomic, enterprise-account point of view, International Accounting Standard No. 17, “Accounting for Leases,” defines a financial lease as “a lease that transfers substantially all the risks and rewards incident to ownership of an asset [while] title may or may not eventually be transferred.”1

The BPM (paragraph 217) defines financial leases as those “in which the effect of a legal change of ownership is achieved … by other means … i.e., lease arrangements that provide for the recovery of all, or substantially all, of the costs of the goods, together with carrying charges. . . . Therefore, as a rule of thumb, a lease arrangement expected to cover at least three fourths of the cost of the goods, together with the carrying charges, is to be taken as presumptive evidence that a change of ownership is intended.”

A somewhat fuller definition was proposed by the OECD Group of Financial Statisticians and expanded by the OECD national accounts meeting in 1981 to read as follows:

A finance lease (sometimes called a full-payment lease) is a contract involving payments over a basic or primary period (during which the agreement cannot be terminated) sufficient in total to cover in full the capital outlay of the lessor together with all subsidiary or financing costs and to give some profit to him. This obligatory period does not exceed the estimated useful life of the asset. The asset is selected by the lessee and delivered to him by the manufacturer. The costs of maintenance and repair, on the subject of the lease, and all risks connected therewith, are borne by the lessee.

At the end of the primary lease, the contract may be extended for a further (secondary) period at a much reduced and perhaps purely nominal rental, or the asset may be sold to the lessee at a very low and perhaps purely nominal price, or the asset may be sold to a third party with some, or perhaps most, of the proceeds from the sale being passed on to the lessee as a “rebate of rental.”

Finally, in recent discussions it has been suggested that it would be sufficient to define a financial lease as one that both parties involved view as being merely an alternative to a loan, although this interpretation on its own may be a little too simple and subjective to stand as a definition.

Clearly, all the definitions enumerated above are intended to define the same phenomenon; they are consistent, even if some are more complete than others. The principal difference is between the BPM definition, in which, as a rule of thumb, a lease is a financial lease if it covers three fourths of the cost of the good, and the OECD definition, which requires a financial lease to cover in full the capital outlay of the lessor together with all subsidiary or financing costs and to give some profit to him or her.

Recent discussions have shown that the OECD (100 percent) definition is too restrictive. Financial lease arrangements exist precisely because there are advantages to both parties, particularly in terms of tax concessions or perhaps investment grants, which mean that the contract may not have to cover 100 percent of the market price of the goods. It is therefore recommended that this condition be relaxed—for example, by adopting the 75 percent rule of the BPM.

Borderline Cases

In introducing the new treatment of financial leasing in the SNA, it is also useful to examine the coverage of financial leasing in concrete terms—in terms of the assets and the transactors involved—since certain borderline cases can be numerically quite important.

As regards types of asset, provided that they meet the definition of financial leasing, it is proposed to include all reproducible fixed assets: machinery and equipment of producers, buildings for industrial or commercial purposes, dwellings, and consumer durable goods (especially cars) obtained by households. In the case of machinery, equipment, and buildings of producers, financial leasing is the straightforward alternative to a loan described above. Financial leasing of dwellings is similarly a straightforward alternative to the more usual mortgage loan. Financial leasing of consumer durables is equivalent to hire purchase.

In principle, however, land is excluded because it has a completely different set of characteristics in national accounts. Payments for the use of land are property income, not a service; land does not depreciate, so the residual value is typically greater than the original value, and so on.

Difficulties arise when the lessor is the manufacturer of the equipment, as frequently occurs in the case of computers and aircraft. The first difficulty is that, even if the period of the primary lease might be long enough to enable the equipment to be amortized, these contracts have often been more akin to operating leasing than to financial leasing because the manufacturer is often responsible for the service and maintenance of the equipment. In addition, of course, the manufacturer only offers such leasing facilities on his own equipment. However, it seems that the trend will increasingly be to separate the provision of the machine from the servicing and provision of the operating system. Therefore, perhaps such long-term leasing of computers and aircraft should be treated as financial leasing.

Second, where leasing facilities are offered by a nonfinancial enterprise (producer or distributor), it is assumed that the unit offering the lease will in general be a separate institutional unit and will maintain a complete set of accounts, so that it can be distinguished from its parent company and will be allocated to the financial institutions sector of the SNA. If, however, parts of nonfinancial enterprises that offer financial leasing contracts cannot be separated in this way, the result would be imputed output of bank services by the nonfinancial enterprise sector, which many experts oppose.

A restriction on the coverage of financial leasing, proposed by the OECD Secretariat for a national accounts meeting in 1983, was that financial leases may only be contracted by producers (including government and private nonprofit institutions serving households) and not by households. The reasons for this restriction were not made clear. They may relate to the impact on gross domestic product (GDP) when the rental payments are in final demand, not in intermediate consumption (see Tables 2-4). However, this reasoning would also exclude international financial leasing. Alternatively, the restriction may have been prompted by the mixed nature of what in some countries are called financial leasing arrangements for the purchase of cars, which include a substantial component of servicing, possibly insurance on the car, and so on. It is proposed here that so long as the definition of financial leasing is met by the contract, leasing of consumer durables by households should not be excluded.

Table 2.Effect of Proposed Change on SNA Production, Income and Outlay, and Capital Finance Accounts: Lessee Is Industry or Enterprise
DisbursementsLessorLesseeTotalReceiptsLessorLesseeTotal
Production account
Intermediate consumption−R−RCharacteristic and other
productsRiRRiR
Adjustment for bank service
imputed
Operating surplus−R +CR − C
Consumption of fixed capitalCC
Gross input,RiRRiRGross outputRiRRiR
of which gross value addedRiRR
Income and outlay account
interest paidRiRiOperating surplusC − RR − C
Interest receivedRiRi
DisbursementsRiRiReceiptsC − R + RiR − CRi
Capital finance account
Gross fixed capital formationa−KKSavingRiR + CRRiC
Net lendingRiRRRiConsumption of fixed capital−CC
Gross accumulationRiRRRiFinancing of gross accumulationRiRRRi
Long-term loansaKRpLong-term loansaKRp−Rp
Net incurrence of financialNet acquisition
assetsof liabilitiesRpRp

The value of the capital good, K, affects the accounts only in the first year; it is therefore omitted from the row and column totals.

The value of the capital good, K, affects the accounts only in the first year; it is therefore omitted from the row and column totals.

Table 3.Effect of Proposed Change on SNA Production, income and Outlay, and Capital Finance Accounts: Lessee Is Government Agency or Private Nonprofit Institution Serving Households
DisbursementsLessorLesseeTotalReceiptsLessorLesseeTotal
Production account
IntermediateCharacteristic and
consumption−R−Rother productsRiRRiR
Adjustment for bank
service imputedRiRi
Services produced
Operating surplusCRC−Rfor own useC − RC − R
Consumption of
fixed capitalCC
Gross input.RiRC − RRi −2R + CGross outputRiRC − RRi −2R + C
of which gross
value addedRiRCRiR + C
Income and outlay account
Interest paidRiRiOperating surplusC−RC−R
Final consumption
expenditureC−RC−RInterest receivedRiRi
DisbursementsRi + CRRi + C − RReceiptsC − R + RiC − R + Ri
Capital finance account
Gross fixed capital
formationa−KKSavingRi + C − RRRiC
Consumption of
Net lendingRiRRiR,fixed capital−CC
Financing of gross
Gross accumulationRiRRRiaccumulationRiRRRi
Long-term loansaKRpRpLong-term loansaKRp− Rp
Net incurrence ofNet acquisition of
financial assetsaK−RpKRpliabilitiesaKRpKRp

The value of the capital good, K, affects the accounts only in the first year; it is therefore omitted from the row and column totals.

The value of the capital good, K, affects the accounts only in the first year; it is therefore omitted from the row and column totals.

Table 4.Effect of Proposed Change on SNA Production, Income and Outlay, and Capital Finance Accounts: Lessee Is Find Consumer
DisbursementsLessorLesseeTotalReceiptsLessorLesseeTotal
Production account
Intermediate
consumptionOutputRiRRiR
Adjustment for bank
service imputedRiRi
Operating surplusC−RC−R
Consumption of fixed
capital−C−C
Gross input,RiRRiRGross outputRiRRiR
of which gross
value addedRiRRiR
Income and outlay account
Interest paidOperating surplusC−RC−R
Final consumption
expenditureaK−RK−RInterest recivedRi
SavingCR + RiRRiC
DisbursementsC−R+RiC−R + RiReceiptsC − R + RiC−R + Ri
Capital finance account
Gross fixed capital
formationa−K−KSavingCR + RiRRiC
Consumption of fixed
Met lendingRiRRRicapital−C−C
Financing of gross
Gross accumulationRiRRRiaccumulationRiRRRi
Long-term loansaKRpLong-term loansaKRp
Net incurrence ofNet acquisition of
financial assets−Rp−Rpliabilitiesa−Rp−Rp

The value of the capital good, Kr affects the accounts only in the first year; it is therefore omitted from the row and column totals.

The value of the capital good, Kr affects the accounts only in the first year; it is therefore omitted from the row and column totals.

II. Proposed Treatment of Financial Leasing in the SNA Accounts and Balance Sheets

It is proposed that the acquisition of capital goods under financial leasing arrangements should be treated as follows in the accounts, balance sheets, and input-output tables.

Details of the Proposed Treatment

•At the time the primary lease is signed, the lessee (user) is treated as having bought the capital asset; its value appears in his or her gross fixed capital formation and, hence, in his or her capital stock and as a fixed asset in his or her balance sheet. Consumption of fixed capital in respect of the asset is also allocated to the user.

•The acquisition of the asset is financed by a loan from the lessor to the lessee, recorded in their respective capital finance and financial balance-sheet accounts.

•The rental payment no longer appears as such anywhere in the system. It is split into two parts: first, interest on the loan, recorded as payments and receipts in the income and outlay account; second, repayment of the loan, recorded in the capital finance account.

•The lessor (the institution providing the loan) should henceforth be classified as a financial institution, not as a nonfinancial enterprise. Even if the lessor is not a bank but an industrial or commercial enterprise, the unit arranging the lease will in general maintain a complete set of accounts so that it can be distinguished from its parent company and treated as a separate financial enterprise.

•In the industry classification, too, units providing financial leasing facilities should be separated from other forms of letting and leasing and should be grouped with credit and insurance. This change has already been made in the newly revised International Standard Industrial Classification (ISIC),2 where ISIC 813, “ Credit granting,” includes financial leasing, whereas ISIC 84, “ Renting,” excludes it.

•The output of units providing financial leasing facilities is to be valued—analogously to that of other financial institutions—by the difference between the property income received (other than income from the investment of their own funds) and the interest paid to creditors.

•If there are any taxes (for example, value-added tax) actually levied on the rental payments that the above treatment has disposed of, these taxes are treated as taxes on the imputed bank service charge.

•As regards the valuation of leased goods under a financial leasing contract, the full equivalent of the market value of the good should be recorded in the capital account, and an offsetting entry should appear in the financial accounts as a liability (which includes the value of the option right). If the capital good is purchased by the lessee at the end of the contract, the option price paid should be treated as the last installment of the loan outstanding. This is in line with the proposed treatment that any goods transferred under a financial leasing arrangement are presumed to have changed ownership at the moment of transfer. If the lessee does not exercise the purchase option and the good is sold to a third party, however, the transaction should be treated as the sale of an existing good. The proceeds of the sale are then used by the lessee for the reimbursement of the last installment of the notional loan made under the financial leasing agreement.

•The division of the rental payment actually paid into the two components, interest and repayment, can be illustrated by means of the following formula. Let c indicate the cost of the equipment; n, the number of periods covered by the primary lease; and s, rental payments per period. Then the effective rate of return, or interest, r, received by the lessor is given by

For simplicity, this assumes that rental payments, s, are constant over time. If not, the calculation is slightly more complicated, but nonetheless feasible. A simpler method, which at first sight seems appealing, is to take the original value of the capital asset as the value of the loan, which is then repaid over n years in equal installments of cln. The difference between this amount and the rental would be considered interest. However, continuing the formula and notation above, in year; the proportion of the total rental payment that constitutes repayment of the principal is given by

and the proportion that is interest is given by

Thus, in the early years the rentals are mainly made up of interest and in later years mainly of repayment of principal. The example in Table 1 shows how much this correct allocation differs from the equal-division method.

Table 1.Comparison of Equal-Division and Correct Distribution of Principal Repayment and Interest Over Time
Assume that
Initial capital (c) = 100
Interest rate (r) = 5 percent
Number of periods (n) = 10.
Then, from the formula for the lessor's effective rate of return given in the text, where s is rental payments per period:
s = 13.
By the equal-division distribution formula,
Repayment of principal (Rp)=10010=10
Repayment of interest (Ri) = 13 −10 = 3.
By the correct distribution formula,
Repayment of principal (Rp)=s(1(1+r)nj1)=131(1.05)11j:j=1…10.
Period values under the two distribution formulas may then be compared as follows, where R is the annual rental; Ri is the interest component of R; Rp is the loan repayment (R = Ri + Rp); C is consumption of fixed capital; and K is the value of the capital good:
EqualCorrect
DistributionDistribution
PeriodRRpRiRpRi
1131038.05.0
2131038.34.7
3131038.84.2
4131039.23.8
5131039.73.3
61310310.22.8
71310310.72.3
81310311.21.8
91310311.81.2
101310312.30.7
Total13010030100.030.0

In practice, countries that have already adopted this new treatment of financial leasing draw their data on the split between interest and loan repayment from enterprises' own accounts, where such a distinction is increasingly being made, from professional associations of financial leasing companies, or from government or central bank agencies responsible for monitoring these financial activities. Data from these sources are likely to be more precise than data resulting from the crude formulas above.

Effect on the Accounts

Tables 2-4 show how these changes affect the production, income and outlay, and capital finance accounts of the SNA. The symbols used are as follows: R is the annual rental; R, is the interest component of R; Rp is the loan repayment (R = Ri + Rp); C is consumption of fixed capital; and K is the value of the capital good.

The lessee will frequently be an industry or nonfinancial corporate or quasi-corporate enterprise; and this case is examined in Table 2. However, nonmarket producers also take out financial leases, and, because of the way their output is valued, the proposed changes have somewhat different implications for the accounts. Table 3 shows what happens if the lessee is a government agency or a private nonprofit institution servicing households. Finally, Table 4 examines the case where the good is acquired for final consumption of households, and the consequences of transborder leasing are discussed. Tables 2-4 show the additions to, or subtractions from, the existing accounts that would result from the proposed changes. The tables are intended to be self-explanatory and will not be discussed in detail. The main points, however, are indicated below.

Table 2 shows that in the common case where the user is an industry, the rental payment R no longer appears in the user's intermediate consumption, so his value added increases; the same rental payment is no longer output for the lessor, whose value added therefore diminishes by R. However, as a financial institution, the lessor now has output of Ri (net interest received) that is offset by the adjustment for imputed bank services, so GDP does not change. Saving and net lending are redistributed from lessor to lessee.

In contrast, as shown in Table 3, when the lessee is a government producer or private nonprofit institution, gross value added is changed by (RiC + R). For GDP as a whole, Ri disappears for the reason noted above, but GDP will still change by R − C.

If the user is a household (Table 4), for final consumption purposes the good is transferred from gross fixed capital formation to final consumption. Incidentally, this makes consumption of fixed capital decline. Saving is particularly affected in the year of acquisition of the good, but this simply aligns this situation with that which would pertain if the goods had been bought on hire purchase. In addition, both value added and consumption in each year of the contract go down by R, and so does GDP (or R − Ri if imputed bank output is allocated to final demand categories).

Similarly, if the lessee is a nonresident unit, in the first year the value of the equipment will no longer be gross fixed capital formation, but an export. For other years there is a decrease in the value of exports of services equal to the value, R, of the rental. As a result, GDP also decreases by R. The external sector account will show imputed interest flows and indebtedness resulting (as in the earlier cases) in a shift of net lending toward the lessee sector, in this case the rest of the world.

Conversely, if the lessor is a nonresident unit, there will be a decrease in the value of imports of services (rentals) and a corresponding increase in the value added of the lessee (user), hence an increase in GDP. In the first year the capital good will be recorded as gross fixed capital formation of the user (and as an import if the capital good itself comes from the rest of the world).

International Accounting Standard, Accounting for Leases (IAS17), International Accounting Standard Committee, September 1982.

United Nations, International Standard Industrial Classification of All Economic Activities, Statistical Papers, Series M, No. 4, Rev. 3 (New York, 1986).

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