Lease
& Finance Guide
A
Glossary of Lease And Finance Terms
(click
in any word or phrase for it's definition / description)
Accelerated
Cost Recovery System (ACRS): The tax depreciation, or cost recovery,
method for Internal Revenue (IRS) purposes, which was introduced by
the 1981 Economic Recovery Tax Act and was effective for all depreciable
property placed in service after December 31, 1980 and before January
1, 1987. ACRS replaced the Asset Depreciation Range (ADR) system and
was replaced itself by the Modified Accelerated Cost Recovery System
of the 1986 Tax Reform Act.
Accelerated
Depreciation: Any depreciation method that allows for greater deductions
or charges in the earlier years of an assets' depreciable life, with
charges becoming progressively smaller in each successive period.
Examples would include the double declining balance and sum-of-the-years
digits methods.
Add-On:
A transaction to add related equipment/software to an existing lease.
Typically this term is used when the new equipment is financed using
the same lease structure (i.e., Fair Market Value, $1.00 Purchase
Option, Fixed Purchase Option, etc.) as was used in the underlying
transaction except that the lease term for the add-on is set so that
it expires coterminously with (on the same date as) the original transaction.
Advance
Payments: Payments made by the Lessee at the inception of a leasing
transaction.
Amortization:
A breakdown of periodic loan payments into two components: A principal
portion and an interest portion.
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APR:
Annual Percentage Rate. The effective rate taking into account compounding
and other fees. The nominal rate of interest for a specific period
(usually one year).
Basis
Point: One one-hundredth of a percent (.01%).
Capital
Lease: A lease that meets at least one of the criteria outlined in
paragraph 7 of FASB 13 and, therefore, must be treated essentially
as an installment purchase for book accounting purposes. The four
criteria are:
--title passes automatically by the end of the lease term
--lease contains a bargain purchase option --lease term is greater
than 75% of economic life of equipment
--present value of lease payments is greater than 90% of the equipment's
fair market value
A Capital Lease is treated by the lessee as both the borrowing of
funds and the acquisition of an asset and corresponding liability
(lease payable). Periodic lessee expenses consist of interest on the
debt and depreciation of the asset.
Captive
Lessor: A leasing company that has been set up by a manufacturer or
dealer of equipment to finance the sale or lease of its own products
to end-users or lessees.
Certificate
of Delivery and Acceptance: A document that is signed by the lessee
to acknowledge that the equipment to be leased has been delivered
and is acceptable. Many lease agreements state that the actual lease
term commences once this document has been signed.
Conditional
Sales Contract: An agreement for the purchase of an asset in which
the lessee is treated as the owner of the asset for federal income
tax purposes (thereby being entitled to the tax benefits of ownership
such as depreciation), but does not become legal owner of the asset
until all terms and conditions of the agreement have been satisfied.
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Cost
of Equity: The return of an investment required by the equity holders
of a firm. Cost of equity can be calculated using any number of different
theoretical approaches and must take into consideration the current
and long-term yield requirements of a firm's investors. A Firm's component
cost of equity is used in calculating the firm's overall weighted-average
cost of capital.
Cost
of Capital: the weighted-average cost of funds that a firm secures
from both debt and equity sources in order to fund its assets. The
use of a firm's cost of capital is essential in making accurate capital
budgeting and project investment decisions.
Coterminous:
Two or more leases that are linked so that both will terminate at
the same time.
Depreciation:
A tax deduction representing a reasonable allowance for exhaustion,
wear and tear, and obsolescence, that is taken by the owner of the
equipment and by which the cost of the equipment is allocated over
time. Depreciation decreases the company's balance sheet assets and
is also recorded as an operating expense for each period. Various
methods of depreciation are used which alter the number of periods
over which the cost is allocated and the amount expensed each period.
Discount
Rate: A certain interest rate that is used to bring a series of future
cash flows to their present value in order to state term in current,
or today's, dollars. Use of a discount rate removes the time value
of money from future cash flows.
Early
Termination: Occurs when the lessee returns the leased equipment to
the lessor prior to the end of the lease term as permitted by the
original lease contract or subsequent agreement. At times this may
result in a penalty to the lessee.
Economic
Life of Leased Property: The estimated period during which the property
is expected to be economically usable by one or more users, with normal
repairs an maintenance for the purpose for which it was intended at
the inception of the lease.
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Economic
Recovery Act of 1981 (ERTA '81): the federal tax act that introduced
ACRS, among other provisions.
End-of-Term
Options: Options stated in the lease agreement that give the lessee
flexibility in its treatment of the leased equipment at the end of
the lease term. Common end-of-term options include purchasing the
equipment, renewing the lease or returning the equipment to the lessor.
Equipment
Schedule: A document incorporated by reference into the lease agreement
that describes in detail the equipment being leased. The schedule
may state the lease term, commencement date, repayment schedule and
location of the equipment.
Fair
Market Value: The price for which property can be sold in an "arms
length" transaction; that is, between informed, unrelated and willing
partners, each of which is acting rationally and in its own best interest.
Fair
Market Value Lease: A lease which includes an option for the lessee
to either renew the lease or purchase the equipment at the term of
the lease at its current value.
Finance
Lease: A lease used to finance the purchase of equipment; not a true
lease. Finance leases are generally considered to be capital leases
from an accounting perspective and non-tax leases from a tax perspective.
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Financial
Accounting Standards Board 13: Statement number 13 of the Financial
Accounting Standards Board (FASB) which establishes standards for
lessees' and lessors' accounting and reporting for leases. This includes
the characterization of a lease as an operating lease or capital lease
for the lessee's purposes.
A
company's assets, liabilities and net income will differ depending
on how it chooses to structure its leases. The provisions of FASB
13 derive from the view that a lease that transfers substantially
all of the benefits and risks of ownership should be accounted for
as the acquisition of an asset and the incurrence of an obligation
by the lessee (a capital lease) and as a sale or financing by the
lessor.
Other leases should be accounted for as the rental of property (operating
leases).
Fixed
Purchase Option: An option given to the lessee to purchase the leased
equipment from the lessor on the option date for a guaranteed price.
Both the date and the price must be determined at the inception of
the lease. A typical fixed purchase option is 10% of the original
cost of the equipment.
Full
Payout Lease: A lease in which the total of the lease payments pays
back to the lessor the entire cost of the equipment including financing,
overhead, and a reasonable rate of return, with little or no dependence
on a residual value.
Interim
Loans: A charge for the use of a piece of equipment from its in-service
date, until the date on which the base term of the lease commences.
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Lease
Purchase: Full Payout, net leases structured with a term equal to
the equipment's estimated useful life. Because many Lease Purchases
include a bargain purchase option for the lessee to purchase the equipment
for one dollar at the expiration of the lease, these leases are often
referred to as dollar buyout or buck-out leases. Lease Purchases are
generally considered to be Capital Leases from an accounting perspective
and non-tax leases from a tax perspective due to their bargain purchase
option and length of lease term.
Lease
Schedule: A schedule to a Master Lease agreement describing the leased
equipment, rentals and other terms applicable to the equipment.
Master
Lease: A continuing lease agreement whereby additional equipment can
be added from time to time merely by describing that equipment in
a new lease schedule executed by the parties. The original lease contract
terms and conditions apply to all subsequent schedules. In contrast
to a lease contract for a single transaction involving a specific
unit of equipment, a Master Lease is essentially a line of credit
to draw from over time in order to purchase equipment.
Municipal
Lease: A lease designed to meet the special needs of state and local
governments. The lease contains a non-appropriation clause, which
states that the only condition under which the entity may be released
from its payment obligation is when the legislature or funding authority
fails to appropriate funds. Since the lessee is a municipality or
an organization supporting the government, it is exempt from paying
federal income taxes. For this reason, the IRS does not charge the
lessor income taxes on leases to these customers.
Net
Present Value: The total discounted value of all cash inflows and
outflows from a project or investment.
Off
Balance Sheet Financing: A lease that qualifies as an Operating Lease
for the lessee's financial accounting purposes. Such leases are referred
to as off-balance sheet financing due to their exclusion from the
balance sheet asset and debt presentation, except for that portion
of the payments that is due in the current fiscal period. Full disclosure
of such transactions is typically made in the auditor's notes to the
financial statements. Periodic payments are recorded as expense items
on the lessee's income statement.
Operating
Budget: A budget that lists the amount of non-capital goods and services
a firm is authorized by management to expend during the operating
period.
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Operating
Lease: A lease which is treated as a true lease (as opposed to a loan)
for book accounting purposes. As defined in FASB 13, an operating
lease must have all of the following characteristics:
--lease
term is less than 75% of estimated economic life of the equipment
--present value of lease payment is less than 90% of the equipment's
fair market value
--lease cannot contain a bargain purchase option (i.e.; less than
fair market value)
--ownership is retained by the lessor during and after the lease term
An
operating lease is accounted for by the lessee without showing an
asset (for the equipment) or a liability (for the lease payment obligations)
on his balance sheet. Periodic payments are accounted for by the lessee
as operating expenses of the period.
Payment
in Arrears: Periodic payments are due at the end of each period.
Payments
in Advance: Periodic payments are due at the beginning of each period.
Present
Value: The discounted value of a payment or stream of payments to
be received in the future, taking into consideration a specific interest
or discount rate. Present Value represents a series of future cash
flows expressed in today's dollars.
Purchase
Option: An option given to the lessee to purchase the equipment from
the lessor, usually as of a specified date.
Recourse:
A type of borrowing in which the borrower (as a lessor funding a lease)
is fully at risk to the lender for repayment of the obligation. The
recourse borrower (lessor) is required to make payments to the lender
whether or not the lessee fulfills its obligation under the lease
agreement.
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Residual
Value: The book value that the lessor depreciates a piece of equipment
down to during the lease term, typically based on an estimate of the
future value, less a safety margin.
Return
on Assets (ROA): A common measure of profitability based upon the
amount of assets invested, ROA is equal to the ratio of either: 1)
net income to total assets or 2) net income available to common stockholders
to total assets.
Return
on Equity (ROE): A measure of profitability related to the amount
of invested equity; ROE is equal to the ratio of either: 1) net income
to owner's equity or 2)net income available to common stockholders
to common equity.
Synthetic
Lease: For accounting/tax purposes, allows lessee to treat the transaction
as off balance sheet. Also allows lessee to treat the transaction
as a loan for available depreciation benefits.
Tax
Lease: A generic term for a lease in which the lessor takes the risk
of ownership (as determined by various IRS pronouncements) and, as
the owner, is entitled to the benefits of ownership, including tax
benefits.
TRAC
Lease: Terminal Rental Adjustment Clause, a lessee guaranteed residual
value for vehicle leases, which will not disqualify the tax status
of a tax oriented vehicle lease.
Turnkey
Financing: Financing that is available for any products or services
necessary to complete a project.
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UCC
Financing Statement: A document, under the UCC, filed with the county
(and sometimes the Secretary of State) to provide public notice of
a security interest in personal property.
Upgrade:
An option that allows the lessee to add equipment to an existing piece
of leased equipment in order to increase its capacity or improve its
efficiency.
Useful
Life: The period of time during which an asset will have economic
value and be useable. The useful life of an asset is sometimes called
the economic life of the asset. To qualify as an operating lease,
the property must have a remaining useful life of 25 percent of the
original estimated useful life of the property at the end of the lease
term, and at least a life of one year.
