Below are many terms in the leasing industry. Eliminate the confusion by consulting this equipment leasing glossary for all your questions.
Accelerated Cost Recovery System (ACRS)
The tax depreciation, or cost recovery, method for Internal Revenue Service purposes that governs all depreciable property placed in service between January 1, 1981 and December 31, 1987. Introduced by the 1981 Economic Recovery Tax Act, ACRS replaced the Asset Depreciation Range (ADR) system and was replaced itself by the Modified Accelerated Cost Recovery System (MACRS) of the 1986 Tax Reform Act.
Any depreciation method that allows for greater deductions or charges in the earlier years of an asset’s depreciable life, with charges becoming progressively smaller in each successive period. Examples of accelerated depreciation are the double declining balance and sum-of-the-years digits methods.
A transaction to add related equipment to an existing lease. Typically, this term is used when the new equipment is financed using the same end of term structure as was used in the underlying transaction (e.g., Fair Market Value, $1.00 Purchase Option) and the add-on’s lease term will terminate on the same date as the original transaction.
Advance Lease Payments
One or more lease payments paid to a leasing company at the beginning of the lease term. Leasing companies commonly require one or two monthly payment(s) to be made in advance.
Alternative Minimum Tax (AMT):
An alternative, separate tax calculation based on the taxpayer’s regular taxable income and increased by the taxpayer’s preferences for the year. Among the preferences that can increase the taxpayer’s alternative minimum taxable income is the accelerated portion of depreciation. After certain exemptions and offsets, the taxpayer is required to pay the larger of the regular tax or the alternative minimum tax.
For accounting or tax purposes, amortization refers to the distribution of the cost of an asset over its useful life. Alternatively, amortization can refer to the process of reducing a debt obligation through periodic level payments that include both an interest and principal portion.
Annual Percentage Rate (APR)
The effective interest rate over the course of a year, taking into account compounding and other fees.
An evaluation of the value of a specific item of property, usually conducted by a person with expertise with respect to such property.
The increase in value of an asset over time.
An item of value.
Audited Financial Statements
An audit is a methodical and objective examination of accounts and items that support the financial statements of the company. It requires the CPA to study the association’s accounting system and evaluate the risk of misstatement from error or fraud. An audit also requires the CPA to test the books and financial records to see if they are producing reliable financial data. Unlike a review, an audit requires the CPA to vouch numbers to source documents, confirm balances or other information, trace transactions through the records. An audit is more work and provides a greater degree of assurance that the financial statements are “fairly stated in accordance with generally accepted accounting principles.”
A payment on a lease that is large in comparison to the other payments. A balloon payment is usually the last payment on the lease.
Bargain Purchase Option
A lease provision allowing the lessee, at its option, to purchase the leased property at the end of the lease term for a price that is sufficiently lower than the expected fair market value of the property.
Units of 1% with each unit equal to 0.01% (1/100%). For example, “50 basis points” is equal to .5% and “200 basis points” is equal to 2%.
For accounting purposes, the value of an asset according to depreciation schedules which may or may not be market value.
A lease that either: 1) automatic transfers title to the equipment at the end of the lease; 2) contains a bargain purchase option; 3) has a lease term greater than 75% of estimated economic life of the equipment; or 4) is structured such that the present value of the lease payments is greater than 90% of the equipment’s fair market value. A Capital Lease must be treated essentially as an installment purchase for book accounting purposes. Therefore, a Capital Lease is both the borrowing of funds and the acquisition of an asset. A Capital Lease does not provide the tax advantages that an operating lease does. For more detailed information, please consult paragraph 7 of FASB 13.
Cash & Cash Equivalents
The value of assets that can be converted into cash immediately. Usually includes bank accounts and highly liquid, marketable investments which can be easily converted into cash, such as Treasury Bills and money market funds. Cash equivalents on balance sheets include securities (e.g., notes) that mature within 90 days.
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.
Certificate of Insurance
A statement from an insurance company or its agent that a certain policy has been written. The certificate usually summarizes the coverage of a certain policy.
Compiled Financial Statements
A compilation is the presentation, in the form of financial statements, of the representations of the owners or managers with no assurance made by the CPA. An accountant generally performs few, if any, procedures, and it is substantially less than a review services report. For this reason, the accountant’s compilation report will include wording similar to the following: “A compilation is limited to presenting in the form of financial statements information that is the representation of management. We have not audited or reviewed the accompanying financial statements and, accordingly, do not express an opinion or any other form of assurance on them.”
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 the legal owner of the asset until all the terms and conditions of the agreement have been satisfied.
Liabilities which are difficult to quantify, or which may or may not come to pass, such as outstanding lawsuits.
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.
Cost Of Goods Sold
The total cost of purchasing raw materials and manufacturing finished goods. Equal to the beginning inventory plus the cost of goods purchased during some period minus the ending inventory.
Two or more leases that are related so that both will terminate at the same date.
Value of cash and cash equivalents, accounts receivable, inventory, marketable securities, prepaid expenses, and other assets that could be converted to cash in less than one year.
The sum of all salaries, interest, accounts payable and other debts due within one year.
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 can be used to alter the number of periods over which the cost is allocated and the amount expensed at each period.
An interest rate that is used to bring a series of cash flows to their present value in order to state them in current, or today’s, dollars.
The termination of a lease before the end of its original term. Depending on the lease structure, an Early Termination may have consequences such as a final payoff consisting of the sum of the remaining payments discounted at a nominal rate and a penalty.
Economic Life of Leased Property
The estimated period of time, with normal repairs and maintenance, that equipment is expected to be economically usable for the purpose for which it was intended at the inception of the lease.
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 leasing company.
Equipment Schedule/Lease Schedule
A document incorporated by reference into a lease agreement, which describes in detail the equipment being leased. The schedule may state the lease term, commencement date, repayment schedule and location of the equipment.
An ownership interest in property or a business.
A document that certifies a party to a transaction is exempted from sales or use tax liability under certain governmental specified circumstances.
Fair Market Value (FMV)
The price for which property can be sold in an “arms length” transaction; that is, between informed, unrelated, and willing parties, each of which is acting rationally and in its own best interest.
Fair Market Value Renewal
A lease that includes an option for the lessee to renew the lease with the equipment value at its fair market value at the end of the lease term.
Statement number 13 of the Financial Accounting Standards Board that establishes standards for lessees’ and leasing companies’ accounting and reporting requirements. The provisions of FASB 13 state that a lease that transfers substantially all of the benefits and risks of ownership should be accounted for as the acquisition of an asset by the lessee and as a sale or financing by the leasing company (a Capital Lease). Other leases should be accounted for as the rentalof property (Operating Leases).
A lease used to finance the purchase of equipment and therefore not a true lease. Finance leases are generally considered to be capital leases from an accounting perspective.
Fixed Purchase Option
An option given to the lessee to purchase the leased equipment from the leasing company 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 covers the entire cost of the equipment including financing, overhead, and a reasonable rate of return, so that there is little or no residual value.
Pre-tax net sales (gross sales minus returns, discounts, and allowances) minus cost of goods sold.
A guaranty is an agreement that is signed by the officers or principals of the company to answer for the debt or obligation of another if that other party or subsidiary company fails to pay or perform. A parent guaranty refers to those agreed to by companies, while a personal guaranty refers to those agreed to by principals or officers of a company.
Incremental Borrowing Rate
The rate that, at the inception of the lease, the lessee would have incurred if it had borrowed funds over a similar term to purchase the leased asset.
A document wherein a landlord or mortgagee acknowledges that certain leased property on the premises is owned by a third party (the leasing company) and is leased to the tenant. In the waiver, the landlord or mortgagee agrees to not interfere with the leasing company’s rights respecting the leased property.
A contract through which an owner of equipment (the leasing company) conveys the right to use its equipment to another party (the lessee) for a specified period of time (the lease term) for specified periodic rental payments.
A lease line of credit allows a leasing customer to obtain additional leased equipment under the same basic lease terms and conditions originally agreed to without having to renegotiate and execute a new lease contract with the leasing company. Each new piece of equipment is listed on a separate schedule, and the specific lease rate for that schedule is dependent upon the policies of the leasing company, the terms and conditions of the Master Lease, and the cost of the equipment.
Full payout, net leases structured with a term equal to the equipment’s estimated useful life. As 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 considered to be Capital Leases.
The length of a lease, usually stated in number of months.
A lease wherein the stream of payments have a debt participant. The ownership of the leased equipment remains with the leasing company. Leveraged Leases can be either recourse or non-recourse leases.
A security interest or an encumbrance upon property.
Long Term Debt
Loans and obligations with a maturity of longer than one year; usually accompanied by interest payments.
A continuing lease arrangement 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.
A lease designed to meet the special needs of state and/or local governments. These leases contain a “non-appropriation” clause stating that the only condition under which the lessee 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 Internal Revenue Service does not charge the leasing company income taxes on leases to these customers.
Net Cash From Financing
Cash flows generated through debt and equity financing.
Net Cash From Investing
Cash flows associated with the buying and selling of fixed assets and business interests.
Net Cash From Operations
The sum of net profit, depreciation, change in accruals, and change in accounts payable, minus change in accounts receivable, minus change in inventories.
Gross sales (revenue) minus cost of goods sold, SG&A, taxes, interest, depreciation, and other expenses.
Net Present Value/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.
Total assets minus total liabilities of an individual or company. For a company, also called owner’s equity or shareholders’ equity or net assets.
In a leveraged lease, the lenders cannot look to the leasing company that sold them the lease for repayment if the lessee fails to meet its payment obligations. The lender’s only recourse is to the lessee and, therefore, the lessee’s credit rating is of prime importance.
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.
A lease that is treated as a true lease for book accounting purposes. An operating lease must have all of the following characteristics: 1) the lease term is less that 75% of estimated economic life of the equipment; 2) the present value of the lease payments is less than 90% of the equipment’s fair market value; 3) the lease cannot contain a bargain purchase option; 4) ownership is retained by the leasing company during and after the lease term. The lessee accounts for an operating lease without showing the equipment as an asset or the lease payment obligations as a liability). For more detailed information, please consult paragraph 7 of FASB 13.
The residual interest in the assets of an entity that remains after deducting it’s liabilities.
One percentage point (1.00%). Five points represents 5.00%. A point also represents 100 basis points.
An option in the lease agreement that allows the lessee to purchase the leased equipment at the end of the lease term for either a fixed amount or at the future fair market value of the lease equipment.
An offer for the purchase of equipment. The leasing company usually sends the Purchase Order to the specified vendor after approval and upon receipt of all documents from the lessee.
The requirement to purchase equipment at a particular time and at a predetermined amount. In a lease transaction, this is a leasing company’s right to force the lessee to purchase the equipment at the end of the lease term for that predetermined amount. A lease agreement containing a Put is a Capital lease and not an Operating lease.
A condition of borrowing money that arises when a leasing company borrows money from another lender to fund a lease and is fully at risk to the lender for repayment of the obligation. The recourse borrower (leasing company) is required to make payments to the lender whether or not the lessee fulfills its obligation under the lease agreement.
The value of the leased property at the end of the lease term as estimated at the time the lease was executed.
Accounting earnings that are retained by the firm for reinvestment in its operations; earnings that are not paid out as dividends but instead reinvested in the core business or used to pay off debt.
Total dollar amount collected for goods and services provided. Also called gross sales.
Reviewed Financial Statements
Financial statements accompanied by an accountant’s expression of limited assurance. The accountant communicates this limited assurance in a report by stating that he or she is not aware of any material modifications that should be made to the financial statements in order for them to be in conformity with Generally Accepted Accounting Principles. The accountant must perform sufficient inquiry and procedures to give a reasonable basis for that conclusion, but doesn’t have to independently verify the accuracy of the data as long as it looks reasonable.
A transaction where the owner sells the equipment it already owns to a leasing company which then leases it back to the same original owner who now becomes the lessee in the transaction. This structure is often used to raise cash or to take the transaction off balance sheet.
Selling, General And Administrative Expenses (SG&A)
Income statement item that combines salaries, commissions, and travel expenses for executives and salespeople, advertising costs, and payroll expenses.
Total assets minus total liabilities; a company’s net worth is the same thing.
Short Term Debt
Debt obligations, recorded as current liabilities, requiring payment within the year; often used to refer to the current portion of bonds or loans.
Defined as any cost above the equipment cost. Examples of this could be software, shipping, installation, hardware, warranty, and labor.
Economic resources with future benefit that are used in the normal operating activity of the organization that can be physically observed, e.g., land, buildings, and equipment.
Terminal Rental Adjustment Clause (TRAC)
A special type of lease where the lessee guarantees the residual value to the leasing company and the lease is treated as a true lease for tax purposes. TRAC leases can only be used for motor vehicles, such as trucks or trailers.
All items of economic value owned by an individual or corporation, especially that which could be converted to cash, including, but not limited to, cash, securities, accounts receivable, inventory, equipment, buildings, vehicles, and other properties. On a balance sheet, assets are equal to the sum of liabilities, common stock, preferred stock, and retained earnings.
All financial obligations, debts, claims, or potential losses.
Also known as an operating lease, where the leasing company qualifies for the tax benefits of ownership and the lessee is allowed to claim the entire amount of the lease rental as a tax deduction.
Uniform Commercial Code (UCC) Financing Statement
A document, under the UCC, filed with a county (and sometimes the Secretary of State) to provide public notice of a security interest in personal property.
The period of time during which an asset will have economic value and be usable. The useful life of an asset is sometimes called the economic life of the asset.
The party that provides the equipment in a lease transaction.
The rate of return to the leasing company in a lease transaction.