What is lease? Why is it needed? Also, explain the importance of lease.

A lease is a legal and binding contract between two parties — the lessor, who owns the asset, and the lessee, who obtains the right to use it — under which the lessee acquires the right to use the lessor's asset for an agreed period in return for periodic payments called lease rentals, while ownership remains with the lessor.

A contractual arrangement: the lease agreement sets forth the terms of the rental — the asset covered, the lease term, the rental amount and timing, maintenance and insurance responsibilities, renewal and purchase options and the consequences of default — and it is enforceable at law.

Parties involved: the lessor is the legal owner who transfers only the right of use, and the lessee is the party who takes possession and enjoys the economic benefits of the asset while paying rentals.

What can be leased: real estate such as land and buildings, and personal property such as plant, machinery, vehicles, aircraft and equipment — in Nepal, vehicle and equipment leasing by finance companies is a common example.

Types of lease: an operating lease is a short-term arrangement, cancellable, where the lessor bears the risk and the rentals are simply charged as an expense; a finance (capital) lease is long-term and non-cancellable, transfers substantially all risks and rewards of ownership to the lessee, and is therefore capitalized as an asset with a corresponding lease liability in the lessee's balance sheet.

Why it is needed:

To use an asset without paying its full cost: the lessee obtains the service of a costly asset by paying only periodic rentals, so no large capital outlay is required at once — a firm needing machinery worth Rs. 5,000,000 can use it against monthly rentals instead.

To conserve funds and avoid obsolescence: scarce funds remain free for working capital and other productive uses, and the risk of the asset becoming obsolete stays with the lessor, which matters most for fast-changing technology such as computers and vehicles.

To obtain finance and flexibility: leasing serves as an alternative source of finance for firms unable to raise loans, since the asset itself is the security, and the shorter operating lease can be cancelled when the asset is no longer needed.

Importance:

To the lessee: it improves liquidity, spreads the cost over the periods that benefit (satisfying the matching principle), lets rentals be claimed as a deductible expense for tax purposes, and avoids the heavy maintenance and disposal problems of ownership.

To the lessor: it provides a steady stream of rental income while ownership and its tax benefits such as depreciation are retained, and the asset can be re-leased or sold at the end of the term.

To the economy and to reporting: leasing channels idle funds into productive assets, helps small and medium enterprises acquire capacity they could not otherwise afford, and — since a finance lease must now be shown on the balance sheet — its proper disclosure gives users a true picture of the entity's obligations.