Equipment Leasing Glossary
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A method of tax depreciation applicable to most equipment placed in service after 1980 and before 1987. Under the Tax Reform Act of 1986, most equipment is now depreciated using the Modified Accelerated Cost Recovery System (MACRS).
ACRS Life
Under ACRS depreciation, equipment was classified by "statutory" life spans of 3, 5, 10 or 15 years; these classifications determined not only the period over which asset costs could be recovered through depreciation, but the amount of Investment Tax Credit that could be claimed.
Advance Rent
A general term used to describe any rents which precede both the commencement of the base lease term and the beginning of the base lease rent obligation, and often applied as a credit to the first base rent payment due. Not usually the same as interim rent.
Alternative Minimum Tax (AMT)
A new tax method, introduced in the Tax Reform Act of 1986, that makes it more difficult for both corporate and non-corporate taxpayers to avoid tax through the use of certain tax benefits known as "tax preference items."
Assignment
A transfer of legal title. In leasing, a transfer of the lessor's interest in a lease and in the leased equipment to another entity such as a financial institution or any other entity which assume's the lessor's position. (A lessee is generally prohibited from assigning its interest in a lease without the consent of the lessor.) The term is also used with regard to a leveraged lease to describe transfers of the first security interest in a lease and lease rentals.
At Risk Rules
Federal tax rules which prohibit individuals and some smaller corporations from deducting tax losses from equipment leases in excess of the amount they have at risk.
Bargain Purchase Option
A provision in the lease language which allows the lessee, at its option, to purchase the equipment sometime during or at the end of the lease term at a price sufficiently below fair market value such that it is a reasonable certainty at the inception of the lease that the lessee will exercise the option to purchase the equipment. The presence of a bargain purchase option will generally cause the lease to be characterized as a capital lease.
Bargain Renewal Option
A provision in the lease language which allows the lessee, at its option, to renew the lease for a rental that is sufficiently below fair market value such that it is a reasonable certainty at the inception of the lease that the lessee will choose to extend the lease.
Base Rent
Also known as basic rent. Rentals paid during the base term of a lease.
Base Term
See lease term.
Base Term Commencement Date
The date on which the base term of the lease commences.
Basic Rent
Same as base rent.
Basis of Equipment
"Capitalized cost" of equipment.
Basis Points
Used for the purpose of calculating fractions of interest percentages. 100 basis points equals 1 percentage point of interest.
Broker
A person/entity who collects a fee for finding suitable lessors for companies wishing to lease equipment.
Capitalized Cost
The total amount (cost of equipment plus other initial, indirect costs) which forms the basis by which future tax benefits are calculated.
Capital Lease
A lease which meets at least one of the criteria in paragraph 7 of the FAS 13 standards, meaning that the lease must be treated essentially as a loan for book accounting purposes. A lease is a capital lease if any one of the following is true: (a) the lease automatically transfers ownership of equipment to the lessee at the end of the lease term; (b)the lease contains an option to purchase equipment at a bargain price; (c) the lease term is equal to 75 percent or more of the estimated useful life of the equipment (does not apply to used property); or (d) the present value of the minimum lease rental payments equals 90 percent or more of the fair market value of the leased property.
Capped Purchase Option (or FMV To A Cap)
A provision in a lease that allows the lessee to purchase the leased equipment at some point during or at the end of the lease term at a price equal to fair market value, but capped so as not to exceed a specified percentage of the equipment's original purchase price.
Casualty Loss Value
See stipulated loss value.
Certificate of Acceptance
A document whereby the lessee acknowledges that the equipment to be leased has been delivered to it, is acceptable to it, and has been manufactured or otherwise constructed in accordance with the lessee's specifications.
Conditional Sale Lease
Also called a hire-purchase agreement, money over money, or lease intended as security. A lease in which an end user essentially "buys" equipment (thus, a conditional sale), and for tax purposes is considered the owner of the equipment at the beginning and throughout the entire term of the lease.
Contingent Rentals
Lease rentals, the payment of which are dependent on some factor other than the passage of time.
Cross Border Lease
A lease transaction in which the lessee is located in one country and the lessor is located in another country. Lease payments can be quoted in either currency.
Default
A failure to perform an essential obligation. One of the most common defaults in a lease occurs when the lessee fails to pay rentals owed on the leased equipment.
Delivery and Acceptance
See Certificate of Acceptance.
Depreciation
A reasonable "allowance" for wear and tear and obsolescence of equipment used in a trade or business; allows the "owner" of the equipment (often the lessor rather than the end user for leased equipment) to "recover" the cost of equipment over its useful life through annual tax benefits (listed in financial statements as "book depreciation").
Direct Financing Lease
For FAS 13 purposes, a non-leveraged lease in which the lessor is not a manufacturer or dealer, and which meets the definition of a capital lease, plus two additional criteria: (a) it must be reasonably certain that minimum lease payments can be collected; and (b) there are no uncertainties regarding any unreimbursable costs which could be incurred by the lessor.
Discounted Cash Flow Analysis
A comparison of the cash flows of two potential investment alternatives, accomplished essentially by calculating the "present value" of each alternative using the same discount rate.
Discount Rate
A percentage rate used to delineate the time value of money; used to calculate the present value of a future inflow or outflow of funds. The rate can be based on a variety of factors and assumptions, including the cost of funds and the desired return on investment.
Double-Declining Balance Depreciation
A way of calculating depreciation by multiply the "adjusted basis" of the equipment (original cost less depreciation taken in previous years) by a percentage twice as great as that which would have been used to depreciate the equipment on a straight-line basis.
Early Buy-Out Option
An option in a lease transaction that allows the lessee one or more opportunities to terminate the lease and purchase the equipment prior to the end of the base lease term.
Early Out Option, Early Termination, or Cancel and Return
An option in a lease transaction that allows the lessee to terminate the lease and return the equipment before the end of the lease term; the liability of the lessee is usually governed by the provisions in the termination schedule (see glossary entry under "termination value"). Sometimes people refer to an Early Buy-out Option as Early Termination.
Effective Lease Rate
The effective rate to the lessee of cash flows resulting from a lease transaction. Can be adequately compared with a loan interest rate only if effects (if any) of federal tax liabilities on the cash flows are taken into account. (Although it should be kept in mind that other factors may be more important to the decision to lease or buy.)
Fair Market Rental
The rental rate for specified equipment that is based upon the expected rental rate for equivalent equipment under similar terms and conditions in an arms-length transaction.
Fair Market Value
The price for which property can be sold in an arms-length transaction.
FAS 13
A 1976 statement from the Financial Standards Accounting Board (FASB) in Stamford, Connecticut which sets formal financial accounting standards for determining (among other things) what distinguishes a"true lease" from a capital lease.
First Amendment Lease
A provision in a lease that allows the lessee to purchase leased equipment at fair market value or a minimum stipulated price, whichever is greater.
Fixed Price Purchase Option
A lease option in which the lessee is given the right to purchase leased equipment at the end of the lease term for a fixed price, predetermined at lease inception.
Full Payout Lease
A lease which qualifies (for FAS 13 purposes) as either a direct financing or sales-type (direct from the vendor) lease. Generally, a lease in which the cash flows from "firm" rentals will provide the lessor with an acceptable return on investment, including the cost of the leased equipment, and factoring in overhead and cost of financing.
Guideline Lease
A tax-oriented lease which complies with all of the IRS guidelines for a "true" lease (as set forth in Rev. Proc. 75-21, 75-28, 76-30, and 79-48).
Half-Year Convention
For depreciation purposes, an assumption (regardless of actual circumstances) that all equipment is placed in service halfway through the year, thereby entitling the equipment owner to only one-half of the first year's depreciation.
Hard Costs
In a lease transaction, leased assets which are considered to be "tangible" (hardware, equipment, facilities, etc.) rather than intangible (software, services, consulting, training, etc.).
Hell or High-Water Clause
A clause in a lease which establishes the lessee's unconditional obligation to pay rentals for the entire term of the lease, regardless of any event which negatively affects the condition of the equipment or any change in the circumstances of the lessee. The term is derived from common provisions in long-term, unconditional leases of ships.
Interim Rent (also, Interim Rate)
The prorated daily rental accruing from the date of delivery, acceptance, and/or funding, until a later starting date of the basic term of a lease. Often occurs in leases where new equipment is acquired over a range of time prior to the commencement of the basic term, or where new equipment can be periodically (e.g., quarterly) added to the lease, and where the equipment is placed in service before the commencement of the new period.
Interim Term
The period of time (term) between the delivery of equipment and the start of the base lease term. This sometimes occurs where a number of deliveries of equipment at various times are to be later combined into one lease.
Lease Line
A lease line of credit, similar to a bank line of credit, that allows a lessee to add equipment to a lease, as needed, under essentially the same terms and conditions, without having to negotiate a new lease.
Lease Rate
The equivalent annual simple interest rate implicit for minimum lease rentals. (Not the same as Net Monthly Lease Rate Factor.)
Lease Schedule
A schedule is attached to a "master lease" agreement, and describes the leased equipment and other terms applicable to that equipment. It is possible for terms in the schedule to supercede provisions contained in the master lease.
Lease Term
Also known as the base term. The fixed, generally non-cancellable period of time (usually overlooking any early termination provisions) during which the lease is in force and during which the lessee will owe rentals and have the use and custody of the leased equipment. For accounting purposes, includes all periods covered by fixed-rate renewal options which at lease inception are likely, for economic reasons, to be exercised. For tax purposes, includes all periods covered by fixed rate renewal options without regard to economic considerations.
Lessee
The party to a lease agreement who is obligated to pay the rentals (and possibly perform other duties), and who is entitled to use and possess the equipment during the lease term.
Lessor
The party to a lease agreement who has legal or tax title to the equipment, and who grants the lessee the right to use the equipment and is, in turn, entitled to the rentals.
Leveraged Lease
A lease in which the lessor/owner purchases the equipment by making a specified equity investment and finances the remaining balance through a long term lender (or lenders). To be considered a leveraged lease, the financing provided by the lender must be substantial to the transaction, and be provided without recourse to the lessor.
Master Lease
A standardized lease document which governs the major provisions of virtually any type of equipment acquisition, subject to any amendments included in attached schedules.
Minimum Lease Rentals
All payments (rentals) which the lessee is obligated to make (or can be required to make) in connection with leased property, including payments for residual value which are essentially guaranteed to the lessor (e.g., certain bargain renewal rents or purchase options).
Modified Accelerated Cost Recovery System (MACRS)
A method of calculating tax depreciation (used as tax deductions) introduced by the Tax Reform Act of 1986 and applicable to most equipment placed in service after 1986. It replaces the older ACRS depreciation schedule. MACRS depreciation begins as double declining balance and then switches to straight line method.
Net Lease
In a net lease, the rentals are payable "net" to the lessor, i.e., all costs related to the use of the equipment (such as maintenance, insurance, and property taxes) are paid by the lessee, over and above the rent payments.
Net Monthly Lease Rate Factor (LRF)
The net monthly rental payment expressed as a percentage of original equipment cost. Usually referred to as simply the Lease Rate Factor. (The term "lease rate" used by itself does not have the same meaning.)
Off Balance-Sheet Financing
Generally, acquiring assets through an operating lease, as opposed to a capital lease. Before 1973, financial reporting standards did not mandate the disclosure of lease obligations (thus these transactions were "off" the financial balance sheets). Under current FAS 13 standards, leased assets that are not capitalized are reported in balance sheet notes rather than listed as liabilities.
Operating Lease
The definition depends upon the context in which it is used. For financial accounting purposes, as per FAS 13, an operating lease is one which does not meet the criteria of either a capital lease or direct financing lease. Generally, the term can refer to a relatively short-term lease which allows the lessee/user to acquire use of an asset for some fraction of the useful life of the asset. The term is also used to describe a lease in which the lessor provides certain services such as maintenance, insurance, and payment of personal property taxes (unlike in a net lease). The term is derived from short-term leases in which the lessor provided a human "operator" along with the leased equipment (e.g., in construction equipment leases). See Lease Accounting section for further information.
Preference Items
Certain tax benefits, such as accelerated depreciation, which may trigger liability for the Alternative Minimum Tax.
Present Value
The equivalent current value for money which is expected to be received (or dispersed) in the future, either by means of a single payment (or payout) or a stream of payments (or payouts) over time. To calculate the present value, the future sum is lessened by some factor (called the "discount rate") which represents the time value of money. For a stream of cash flows, the net present value is the sum of the present value of each inflow or outflow.
Renewal Option
An option given to the lessee to extend the term of a lease at the expiration of the base term.
Rentals (also, Rents)
Payments required under a lease, to be made by a lessee to a lessor for the use of leased equipment.
Residual, or Residual Value
The value of leased equipment at the conclusion of the lease term. (Note that the lessor/owner is not required to "book" any residual for financial accounting purposes.)
Sale-Leaseback
A lease transaction in which the the owner of equipment sells it to another business/financing entity which then leases the same equipment back to the original owner.
Schedule
See "lease schedule."
Soft Costs
In a lease transaction, leased assets which are considered to be "intangible" (software, services, consulting, training, etc.) rather than tangible (hardware, equipment, facilities, etc.).
Step Rentals
Rentals that change during the lease term, usually from lower amounts at the beginning of the lease to higher amounts during the later periods. According to the Internal Revenue Code, rentals under a true lease may not vary more than plus or minus ten percent during the lease term unless they are tied to an index that tracks market changes or unless the variations arise from some reason other than tax avoidance. Sometimes called a 90-110 lease.
Stipulated Loss Value
A schedule included in a lease which states the agreed value of equipment at various times during the term of the lease, and which establishes the liability of the lessee to the lessor in the event that the leased equipment is "lost" or rendered unusable during the lease term due to a casualty loss. (Not to be confused with termination value.)
Straight-Line Depreciation
Depreciation calculation whereby an equipment owner takes an equal amount of depreciation in each year of the equipment's useful life (for tax purposes called the recovery period).
Sublease
A lease transaction in which the use of leased property is released by the lessee to a third party, usually while the lease agreement between the original parties remains in force.
Tax-Oriented Lease
A "true lease" for federal tax purposes.
Technology Refresh Option
An option in a lease agreement that allows the lessee at certain stages of the lease term to "trade in" older equipment for newer technology, usually extending the base term of the lease and/or otherwise changing payment terms.
Termination Value
A provision sometimes included in a lease that permits the lessee to terminate the lease during the lease term in the event the leased equipment becomes obsolete or surplus to the lessee's needs. In the event of a termination, the liability of the lessee is set forth in a "termination schedule" which specifies the values assigned to the equipment at various times during the lease term (to protect the lessor from loss of investment). Not to be confused with either an insured loss value schedule or stipulated loss value schedule.
TRAC Lease
Used to describe certain leases restricted to the motor vehicle leasing industry; a lease that has what is called a "Terminal Rental Adjustment Clause," meaning that ownership passes to the lessee with the payment of the TRAC, which usually equates to the buyer's assumed residual value. Despite the final and mandatory purchases, TRAC leases are specifically regarded as true leases for tax purposes (i.e., tax benefits are accorded to the lessor).
True Lease
A true lease is a transaction that qualifies as a lease under the Internal Revenue Code (compare with capital lease), such that the lessee can claim rental payments as a tax deduction and the lessor can claim tax benefits associated with equipment ownership (such as depreciation deductions and the Investment Tax Credit).
Uniform Commercial Code (UCC)
A list of protocols or standards, adopted by every state except Louisiana, which govern commercial transactions such as leases.
UCC Filings
Documents filed (in accordance with the Uniform Commercial Code) in each state where equipment is located in order to perfect a lessor's ownership interest in leased equipment. Often a "UCC Search" is performed before filing in order to document a first security interest in the equipment.
Useful Life
The length of time that equipment (or some other asset) is expected to be usuable, and therefore can be said to have economic value to the user. The useful life of an asset is sometimes called its "economic life." To qualify as a true lease, equipment must have a remaining useful life of at least 20 percent of the original estimated useful life, and the remaining useful life must be for a minimum of one year.
Vendor Lease
A lease offered by a manufacturer or dealer (i.e., vendor) to its customers as a means of financing and increasing utilization of its products.
Yield
The growth rate or interest rate earned by the lessor (or other equity participant) in a lease, measured by the rate at which cash flows (sometimes including tax benefits) permits recovery of the investment. Desired yields vary widely due to credit quality of the lessee, degree of residual risk, lessor's cost of funding, etc.
