The Basics

A lease is a contractual agreement between a lessee and a lessor. The agreement establishes that the lessee has the right to use an asset and in return must make periodic payments to the lessor, the owner of the asset. The lessor is either the asset's manufacturer or an independent leasing company. If the lessor is an independent leasing company it must buy the asset from a manufacturer. Then the lessor delivers the asset to the lessee, and the lease goes into effect.

As far as the lessee is concerned, it is the use of the asset that is most important, not who owns the asset. The use of an asset can be obtained by a lease contract.

Because the user can also buy the asset, leasing and buying involve alternative financing arrangements for the use of an asset. This is illustrated in Figure 1.

The specific example in Figure 1 happens often in the computer industry. Firm U, the lessee, might be a hospital, a law firm, or any other firm that uses computers. The lessor is an independent leasing company who purchased the equipment from a manufacturer such as IBM or Apple. Leases of this type are called direct leases. In the figure, the lessor issued both debt and equity to finance the purchase.

Of course, a manufacturer like IBM could lease its own computers, though we do not show this situation in the example. Leases of this type are called sales-typeleases. In this case, IBM would compete with the independent computer-leasing company.

Figure 1. Buying versus Leasing