Financial Management and Strategic Management · Types of Financing

Lease Financing and Hire Purchase for CA Intermediate

Updated 4 October 2026 · Fact-checked

Lease financing lets you use an asset by paying rentals while the owner (lessor) keeps legal title. A finance lease transfers most risks and rewards of ownership; an operating lease does not. Hire purchase gives the hirer ownership after the last instalment. Compare them on ownership, risk, tax and accounting treatment.

Understand Lease Financing and Hire Purchase

A lease is a contract in which the owner of an asset (the lessor) allows another party (the lessee) to use it for an agreed period in return for periodic payments called lease rentals. The lessee gets the use of the asset without buying it. So it works as a source of medium-term and long-term finance.

There are two main types. In a finance lease, the lease runs for most of the asset's useful life. It usually cannot be cancelled. The lessee bears maintenance, insurance and the risk of obsolescence. The lessor is mainly a financier. In an operating lease, the term is short compared with the asset's life. It is often cancellable. The lessor bears maintenance and obsolescence risk and expects to lease the asset again or sell it. Think of renting a car for a week versus taking it on a long non-cancellable lease.

Two special structures are important. In sale and leaseback, a firm sells an asset it already owns to a lessor and leases it back at once. The firm gets cash, and still uses the asset. In a leveraged lease, three parties are involved: lessor, lessee and lender. The lessor puts in only part of the cost (equity) and borrows the rest from the lender, often on a non-recourse basis, with the rentals assigned to the lender.

Hire purchase is different. The buyer (hirer) takes the asset and pays in instalments. It is distinguished mainly by the option or agreement to buy: title passes to the hirer when the last instalment is paid. As a general tax rule, the owner claims depreciation. In a lease, the lessor is the owner and claims depreciation, while the lessee deducts the lease rentals paid (which is why rentals are taken after tax in a buy-versus-lease comparison). In hire purchase, the hirer is treated as the owner and claims depreciation, along with the interest component of the instalments. Note that a finance lease may also provide for transfer of ownership at the end, so do not rely on title transfer alone to tell the two apart; look at the agreement to buy.

Advantages of leasing: little or no down payment, 100% financing of the asset, protection against obsolescence in operating leases, and preservation of borrowing capacity (in some cases). Disadvantages: the total cost can be higher than a loan, the lessee usually does not own the asset (and does not get its residual value), and a default can lead to loss of the asset.

Key rules to remember

Present value of lease rentals: PV of rentals = Σ [Rental in year t ÷ (1 + k)^t]; k is normally the after-tax cost of borrowing when comparing lease with borrow-and-buy. Use after-tax rentals if rentals are tax deductible.
Annual lease rental (equated): Rental = Cost of asset ÷ PV annuity factor (n years, rate r); Used by the lessor to fix a rental that recovers cost and return. If there is a residual value, deduct its PV from cost first.
Net advantage of leasing (NAL): NAL = PV of cost of buying − PV of cost of leasing; Positive NAL means lease. Negative NAL means buy. Be consistent with the cash outflows you treat as costs.
Tax shield on rentals: Tax saved = Rental × tax rate; After-tax rental = Rental × (1 − tax rate).
Tax shield on depreciation: Tax saved = Depreciation × tax rate; Relevant for the buy option. Depreciation is a non-cash item, so only the tax saving is a cash flow.

How to solve Lease Financing and Hire Purchase questions

Use this method for any lease question, whether it is theory or a lease-versus-buy numerical.

1Read the question and decide if it asks for theory (types, differences, pros and cons) or a numerical (lease vs buy, rental, hire purchase).
2For theory, define the term, then give points in a clear list. For comparisons, use the same heads on both sides: ownership, term, risk, maintenance, tax, accounting.
3For a numerical, list the cash flows of the buy option: purchase cost, tax saving on depreciation, tax saving on interest if given, and the salvage value at the end.
4List the cash flows of the lease option: after-tax rentals, and any other lessee costs as given.
5Choose the discount rate as stated. If not stated, use the after-tax cost of debt. Compute the present values using the discount factors given.
6Compare the present value of net outflows of each option. Pick the lower cost, or state the NAL.
7Write a one-line conclusion with the decision and any non-financial points such as obsolescence or control of the asset.

Quickest way: Fast approach for MCQs and written answers

When to use it: Use it when time is short and the question gives a few cash flows with discount factors.

For MCQs on types, check these clues: non-cancellable and long term means finance lease; cancellable and short term with lessor maintenance means operating lease.
An option or agreement to buy, with title passing on the last instalment, points to hire purchase rather than a lease.
Own asset sold and leased back means sale and leaseback. Three parties with a lender means leveraged lease.
For a numerical, write two columns, Buy and Lease, with years across. Fill the after-tax figures first, then multiply by the discount factors.
Only relevant cash flows count. Ignore depreciation itself, keep only its tax saving.
Show every line of working. Step marks are given even if the final figure is wrong.
End with one line: lease if its present value of cost is lower.

Common mistakes in Lease Financing and Hire Purchase

Treating depreciation as a cash outflow in the buy option.
Depreciation appears in the question as a cost, so it feels like a payment.
Fix: Depreciation is non-cash. Include only the tax saving on it (Depreciation × tax rate).
Discounting after-tax cash flows at the pre-tax rate of interest.
The question gives one interest rate and you use it directly.
Fix: Unless told otherwise, convert to after-tax: rate × (1 − tax rate), then discount after-tax cash flows.
Calling hire purchase a finance lease, or the reverse, only because both run for a long period.
Both finance the asset over a long period, so they look alike.
Fix: Look for the option or agreement to buy. In hire purchase, title passes to the hirer on the last instalment. In a lease, the lessor stays the owner, even though some finance leases allow ownership to transfer at the end.
Mixing up who claims depreciation.
Students remember that one party claims it but not which.
Fix: As a general tax rule, the owner claims depreciation. In a lease, that is the lessor, while the lessee deducts the rentals instead. In hire purchase, the hirer is treated as the owner and claims depreciation, along with the interest portion of the instalments.
Forgetting the salvage value in the buy option.
It appears at the end of the question and is easy to miss.
Fix: Include salvage value as an inflow in the last year of the buy option, discounted. In the lease option the lessee gets no salvage.
Writing one-sided pros and cons in the theory answer.
Students list only advantages when asked to evaluate.
Fix: Give both advantages and disadvantages, then a short view on when leasing suits a firm.

Worked examples

Example 1

List five differences between a finance lease and an operating lease.

Show the solution

Compare on the same heads: term, cancellability, risk, maintenance, and the lessor's role.
Write each difference as a pair so the examiner sees a clear comparison.

Answer: 1. Term: A finance lease covers most of the asset's useful life; an operating lease covers a period much shorter than its life. 2. Cancellation: A finance lease is generally non-cancellable; an operating lease can often be cancelled by notice. 3. Risks and rewards: In a finance lease the lessee bears most of them; in an operating lease the lessor does. 4. Maintenance and insurance: The lessee bears them in a finance lease; the lessor usually bears them in an operating lease. 5. Lessor's role: In a finance lease the lessor is mainly a financier and recovers cost plus return from rentals; in an operating lease the lessor re-leases or sells the asset to recover cost.

Example 2

A firm can buy a machine for ₹10,00,000 or lease it for 3 years at an annual rental of ₹4,00,000 payable at the end of each year. Tax rate is 30%. Depreciation is ₹3,00,000 a year for 3 years, and the machine is sold at the end of year 3 for its written-down value of ₹1,00,000 (ignore any tax on this sale). The after-tax discount rate is 10%. PV factors at 10%: year 1 = 0.909, year 2 = 0.826, year 3 = 0.751. Should the firm lease or buy?

Show the solution

Buy option: outflow at year 0 is ₹10,00,000.
Tax saving on depreciation each year = ₹3,00,000 × 30% = ₹90,000.
Sum of PV factors = 0.909 + 0.826 + 0.751 = 2.486.
PV of tax savings = ₹90,000 × 2.486 = ₹2,23,740.
PV of sale proceeds at end of year 3 = ₹1,00,000 × 0.751 = ₹75,100.
Net PV cost of buying = ₹10,00,000 − ₹2,23,740 − ₹75,100 = ₹7,01,160.
Lease option: after-tax rental = ₹4,00,000 × (1 − 0.30) = ₹2,80,000 per year.
PV of lease cost = ₹2,80,000 × 2.486 = ₹6,96,080.
NAL = ₹7,01,160 − ₹6,96,080 = ₹5,080, which is positive.

Answer: Lease. The present value cost of leasing is ₹6,96,080 against ₹7,01,160 for buying, so the net advantage of leasing is ₹5,080.

Exam tips

Differences between finance lease and operating lease, and lease versus hire purchase, are common theory questions. Learn a fixed list of five to six points for each.
In lease-versus-buy numericals, show the two options separately, then compare. A clear table of workings in your answer book earns step marks.
Read the question for which rate to use for discounting and whether rentals are paid at the start or end of the year.
Define sale and leaseback and leveraged lease in two lines each, with who the parties are. Short notes on them are easy marks.
For MCQs, spot the key clue: option to buy with title passing on the last instalment means hire purchase; lender involved means leveraged lease; same asset sold and taken back means sale and leaseback.

Practice questions from Types of Financing

Lease Financing and Hire Purchase in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Lease Financing and Hire Purchase: frequently asked questions

What is the main difference between a finance lease and an operating lease?

In a finance lease the lessee bears most risks and rewards of ownership, and the lease usually runs for most of the asset's life and cannot be cancelled. In an operating lease the lessor keeps these risks, the term is short and cancellation is often allowed.

How is hire purchase different from leasing?

Hire purchase carries an option or agreement to buy, and the hirer becomes the owner on paying the last instalment. As a general tax rule, the owner claims depreciation: the hirer in hire purchase (along with the interest part of the instalments), and the lessor in a lease. The lessee only gets the right to use the asset and deducts the rentals paid.

What is sale and leaseback?

A firm sells an asset it owns to a lessor and leases it back immediately. It raises cash from the sale and continues to use the asset by paying rentals. It is useful for improving liquidity.

What is a leveraged lease?

It is a lease with three parties: the lessor, the lessee and a lender. The lessor funds only part of the asset cost and borrows the rest from the lender, who is usually repaid from the lease rentals.