Equipment Leasing Glossary - Leasing Terms Explanations

We provide this glossary as a reference of leasing and financial terminology. It is meant to be informative only and we recommend contacting your own accounting professional if you have any questions.

A B C D E F G H I J K L M N O P Q R S T U V W X Y Z

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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.

Accelerated Depreciation: 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.

Acknowledgment: A formal statement by a party before a notary public to the effect that they have executed a specific instrument or document.

Add-On: 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

Additional Insured: A party other than a party in whose name insurance is issued who is also protected against losses covered by such a policy.

Advance lease payments: One or more lease payments required to be paid to the lessor at the beginning of the lease term. Lease structures commonly require a nominal payment to be made at lease signing.

Agent: A person who has legal authority to act for and represent another party in dealing with third parties.

Agreement: The bargain of the parties in fact as found in their language or by implication from other circumstances.

All-risk insurance: This is an insurance policy that covers an insured against loss from any peril other than those specifically excluded by the terms of the policy.

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.

Annual Percentage Rate (APR): The effective interest rate over the course of a year, taking into account compounding and other fees.

Appraisal: An evaluation of the value of a specific item of property, usually as conducted by a person with expertise about that property.

Appreciation: The increase in value of an asset over time.

Asset: 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."

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Balloon Payment: A payment on a loan that is unusually large in comparison to the other payments on the loan. A balloon payment is usually the final payment on a loan.

Bargain Purchase Option: A renewal option that will, as a certainty, be exercised because the consideration to be given for the purchase is so nominal as to be insignificant.

Basis Points: 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%.

Bill of Sale: A written document that evidences the transfer of ownership of property.

Book Value: For accounting purposes, the value of an asset according to depreciation schedules which may or may not be market value.

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Capital Lease: 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 Flow: Income inflows less expense outflows, including debt service, over a specified period.

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 the D&A has been signed. After the D&A is signed, the vendor is paid.

Certificate of Insurance: A statement from an insurance company or its agent that a certain policy has been written. The certificate usually summarizes the policy’s coverage.

Closed-end Lease: A lease that does not contain a purchase or renewal option, thereby requiring the lessee to return the equipment to the lessor at the end of the initial lease term.

Co-lessee: An additional lessee to the lease. The lease will usually provide that the co-lessee is jointly and severally liable on the lease with the lessee. Most leases to non-public companies with individuals who own 20% or more are personally guaranteed.

Collateral: Security, usually property (real, personal, or intangible) pledged to secure performance of an agreement.

Commercial Lease: A lease in which the lessee has entered into the lease transaction for business or commercial purposes; business lease.

Commitment Fee: A fee that is required by the lessor at the time the proposal or commitment is accepted by the lessee in order to lock in a specific lease rate and/or other lease terms. A commitment letter is a document prepared by the lessor that details its commitment, including rate and term to provide lease financing to the lessee. This document precedes final documentation and may or may not be subject to other conditions, such as lessor credit approval, guarantors, collateral, etc. This fee is typically at least $2,000 or 3% of the asset cost.

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. This entitles the lessee to the tax benefits of ownership, such as depreciation, but the lessee does not become the free and clear owner of the asset until all terms and conditions of the agreement have been satisfied.

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."

Consumer Lease: A lease in which the lessee has entered into the lease transaction for personal, family or household purposes. In some states certain agricultural leases may be considered consumer leases.

Contingent Liabilities: 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.

Coterminous: Two or more leases that are related so that both will terminate at the same date.

Current Assets: 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.

Current Liabilities: The sum of all salaries, interest, accounts payable and other debts due within one year.

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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 can be used to alter the number of periods over which the cost is allocated and the amount expensed at 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 them in current, or today’s dollars. The Federal Funds rate is very common.

- E -

Early Termination: 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.

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 options include purchasing the equipment, renewing the lease or returning the equipment to the lessor. Options are sometimes given as an amendment to the lease documents and are not made part of the actual lease document.

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.

Equity: An ownership interest in property or a business.

Exemption Certificate: A document that certifies a party to a transaction is exempted from sales or use tax liability under certain governmental specified circumstances.

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FASB 13: Statement of Financial Accounting Standards No. 13 issued by the Financial Accounting Standards Boards. This statement sets forth the generally accepted accounting procedures for lessor and lessee accounting and financial statement reporting.

Fair Market Value: The value of a piece of equipment if the equipment were to be sold in a transaction determined at arm’s length, between a willing buyer and a willing seller, for equivalent property and under similar terms and conditions Simply, the actual market value of the leased asset at the time the lease term is ended.

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.

Finance Lease:1). As most frequently used, a net lease which has as its purpose the financing of the use of property for a major portion of the property’s useful life. The term is typically used in reference to leases written by third-party lessors (see third-party lessors). 2). General term applied to most types of equipment leases. Typically, a finance lease is a full-payout, non-cancelable agreement, and the lessee is responsible for maintenance, taxes, and insurance.

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 lessor recovers, through the lease payments, all costs incurred in the lease plus an acceptable rate of return, without any reliance upon the leased equipment’s future residual value.

Full-Service Lease: A lease that includes many additional services such as maintenance, insurance and property taxes that are paid by the lessor, the cost of which is built into the lease payments.

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Gross Lease: A lease in which the lessor is liable for insurance, property taxes, maintenance expenses, and the like; aka, operating lease; service lease; maintenance lease. (Compare: net lease).

Gross Profit: Pre-tax net sales (gross sales minus returns, discounts, and allowances) minus cost of goods sold.

Guarantor: One who is obligated on a guaranty agreement. A guarantor may be another company and/or an individual.

Guaranty: An agreement to answer for the debt or obligation of another if that other party fails to pay or perform.

- I -

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.

Insurance Interest: An interest capable of being protected by a policy of insurance.

Investment Tax Credit (ITC): A credit against taxes otherwise due from a taxpayer under the Internal Revenue Code. The credit is generally computed as a percentage of the costs of certain types of assets. It is currently not a part of the IRS Code.

- L -

Landlord Waiver: A document in which a landlord acknowledges that certain property on its tenant’s premises is owned by a third party (the lessor) and is leased to the tenant and in which a landlord agrees to recognize and not interfere with the lessor’s rights respecting the lessor’s property.

Lease: A transaction in which use and possession but not title to tangible personal property is transferred for a consideration.

Lease Agreement: The contractual agreement between the lessor and the lessee that sets forth all the terms and conditions of the lease.

Lease Line: A pre-approved amount of leasing allowed a lessee by a lessor. United Financial Services commonly approves lessees for lines of credit.

Lease Payment: The periodic payment made during the lease term. Such payments are usually of an even amount but it is not uncommon for a lease to have “gaps” in the payment amount, or to be otherwise contoured to fit, for example, the seasonal fluctuations of a lessee’s income. (Generally, leasing may provide for more creativity in this regard than a loan.)

Loss Payee: A party entitled to receive proceeds from an insurance settlement arising in connection with a covered casualty or loss.

Lease Purchase: 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.

Lease Term: Length of a lease, usually stated in monthly increments but occasionally stated in quarterly or yearly increments.

Leveraged Lease: 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.

Lien: 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.

- M -

Master Lease: 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.

Minimum Lease Payments: From the lessee perspective, all lease payments that are required to be made, may be required to be made or, in all probability, will be made to the lessor per the lease agreement. Minimum lease payments for the lessee include, but are not limited to, the lease payments (excluding executory costs) during the non-cancelable lease term, bargain purchase options, and any put options, the amount of any lessee residual guarantees and nonrenewal penalities that are insufficiently severe to cause renewal. Minimum lease payments for the lessor include all payments to be received from the lessee, as described above, as well as the amount of any residual guarantees by unrelated third-party guarantors.

Modified Accelerated Cost Recovery System (MACRS): The current tax depreciation system as introduced by the Tax Reform Act of 1986, Generally effective for all equipment placed in service after December 31, 1986.

Municipal Lease: 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.

- N -

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.

Net Income: Gross sales (revenue) minus cost of goods sold, SG&A, taxes, interest, depreciation, and other expenses.

Net Lease: A lease in which all costs in connection with the use of equipment, such as maintenance, insurance and property taxes, are paid for separately by the lessee and are not included in the lease rental paid to the lessor

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.

Net Worth: Total assets minus total liabilities of an individual or company. For a company, also called owner's equity or shareholders' equity or net assets.

Non-recourse Loan: 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.

- O -

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 Lease: 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.

Owner's Equity: The residual interest in the assets of an entity that remains after deducting it's liabilities.

- P -

Personal Property Tax: A tax on the ownership of personal property. This tax is usually charged by a state or borough/county/parish annually for the assets leased for the prior year.

Purchase Option: An option in the lease agreement that allows the lessee to purchase the leased equipment at the end of the lease term of the lease for either a fixed amount or at the future fair market value of the leased equipment.

Purchase Order: An offer for the purchase of an item of property. The purchase order will normally specify the terms and conditions under which the buyer is willing to make the purchase; when accepted by the seller it becomes the purchase contract.

Put: 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.

- R -

Renewal Option: An option in the lease agreement that allows the lessee to extend the lease term for an additional period of time beyond the expiration of the initial lease term, in exchange for lease renewal options. Residual The value of the lease property at the end of the lease term as estimated at the time the lease is executed; term value. Although the terms “residual value” or “term value” are sometimes used in reference to the actual value of the property at the conclusion of the term, the term “realized value” is the more commonly used and more appropriate term for the actual value of the property at the conclusion of the lease term.

Residual Value: The value, either actual or expected, of leased equipment at the end, or termination, of the lease.

Retained Earnings: 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.

Revenue: 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.

Rule of 78: An accelerated method of allocating periodic earnings in a (Lease or a Loan) based upon the sum- of- the- years method.

- S -

Sale Leaseback: 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.

Security Deposit: A specific amount paid at the inception of the lease by the lessee to insure full compliance with the lease and to provide the lessor with some protection against faults, delays, or other failures of performance by the lessee. Occasionally, advance periodic lease payments may serve the purpose of a security deposit, but more frequently, the security deposit is a separately identified obligation.

Service Lease: A lease in which the lessor provided complete service, maintenance, and care for the leased equipment; maintenance lease; operating lease; gross lease.

Shareholders' Equity: 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.

Soft Cost: Defined as any cost above the equipment cost. Examples of this could be software, shipping, installation, hardware, warranty, and labor.

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Tangible Assets: 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.

Total Assets: 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.

Total Liabilities: All financial obligations, debts, claims, or potential losses.

True Lease: 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.

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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.
Useful Life: 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.

- V -

Vendor: A purveyor of equipment from whom a lessor purchases equipment at the specific request of a lessee for a lease to that lessee; a supplier.

Glossary of Terms