Key Equipment Finance and Leasing

Terms & Definitions

Accelerated Cost Recovery System (ACRS): The depreciation schedule of the Economic Recovery Tax Act of 1981 (ERTA), modified by the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), that allows faster write offs of plant and equipment classified as 3,5, or 10 years property. The accelerated cost recovery system (ACRS) replaced the asset depreciation range (ADR) system which was built on the concept of useful life.

ACRS (Modified): The Tax Reform Act of 1986 modified the ACRS by prescribing depreciation methods for each ACRS class in lieu of statutory tables. Equipment is assigned among 3,5,7,10,15, or 20 year classes depending on ADR lives.

Advanced Lease Payment(s): The payment or payments made at the initiation of the lease contract, i.e. first rental payment or first and last rental payments.

Alternative Minimum Tax: An alternative, separate tax calculation based on the taxpayer's regular taxable income, increased by the taxpayer's preference for the year. The resulting amount is called the alternative maximum taxable income (AMT). After certain exemptions and offsets, the taxpayer determines his/her AMT and is required to pay the larger of the regular tax or alternative minimum tax. Among the preferences which can increase the taxpayer's AMT is the accelerated portion of depreciation, thereby making it more likely for a taxpayer that buys equipment to be subject to the AMT rather than regular tax.

Authorized Signature: A signature by a key person authorized by a company to obligate the company on a long-term lease. An authorized signer will usually be substantiated by the Corporate Resolution which specifies who can sign and what his/her responsibilities may be.

Bargain Renewal Option: A lease provision allowing the lessee, at this option, to renew the equipment lease for a rental rate predetermined at lease inception, that is substantially lower than the expected fair market value at the date the option can be exercised.

Broker:  A broker acts as the middle-man between the lessee (the user of the equipment) and the full service leasing company that ultimately provides the credit approval, documentation, funding, and billing.  There are many leasing companies that act as brokers and receive a fee for their work.  There are fewer full service leasing companies that have the ability to hold and service their leases throughout the entire term of the lease.  The full service lessor provides greater control for the lessee and/or vendor in the event the lessee wants to upgrade or early terminate their lease. Since there is no middleman, doing business directly with a full service lessor usually results in a lower lease rate for the lessee and a higher sale price for the vendor.

Capital Lease: A FASB 13 accounting classification to be accounted for by a lessee as a purchase and by the lessor as a sales or financing agreement, if it meets any one of the following criteria: (a) The lessor automatically transfers ownership to the lessee at the end of the lease term; (b) the lease contains an option to purchase the asset at a bargain price; (c ) the lease term is equal to 75% or more of the estimated economic life of the property (exceptions apply for used property leased toward the end of its useful life); or (d) the present value of minimum lease rental payments is equal to 90% or more of the fair market value of the leased asset, less related investment tax credits retained by the lessor (Also see operating lease).

Certificate of  Acknowledgement and Acceptance of Leased Equipment: A written verification by the lessee that they have received the equipment to be leased and have accepted the equipment after full inspection thereof as satisfactory for the purpose of the lease. Most leases begin after the date stated on the certificate of acceptance.

Closed End Lease: A true lease in which the lessor assumes the depreciation risk. The lessee bears no obligation at the end of the lease. This key finance term is used to distinguish the lease from an open-end lease.

Coterminous: Two of more leases that end at the same time. A Coterminous Addendum can be used allowing you to add equipment to an existing lease, adjusting the payments to reflect the addition. Both the original lease and the addendum will terminate at the same time.

Cross Corporate Guaranty: A guarantee by one corporation to pay the lease obligations of another corporation.

Default: If a lessee does not comply with the terms of the lease, a default occurs. Generally, after a default, the lessor can exercise all of its rights under the lease to repossess the property and seek money damages.

Depreciation: A method for determining the useful life of a piece of equipment and for costing its value over the years of its active use. The total depreciation expense is equal to the difference between the initial cost of the unit and its estimated residual or salvage value. When divided over the years of the equipment's usefulness, this periodic expense can be deducted from income taxes each year.

Direct Finance Lease: Same as a capital lease except this accounting classification only applies to a lessor.

Dollar Buyout: Assuming that the lessee is not in default, an option at the end of the lease to buy the leased property for $1.00

Estimated Useful Life: The estimated time period leased equipment is expected to be useful. Estimated useful life is used to calculate the maximum allowable term of a "tax-oriented lease".

Estimated Residual Value: For purposes of calculating the maximum allowable term of a "tax-oriented lease", this is the "fair market value" of the lease equipment at the end of the lease term, calculated in constant dollars excluding inflation or deflation.

Exemption Certificate: A document exempting a lessor from paying sales tax on the equipment being leased. A lessor may be buying the equipment for "re-sale" as would a vendor/supplier, while a lessee may be tax exempt for other reasons, i.e., non-profit entity or a bank.

Effective Lease Rate: The effective lease rate (for the lessee) of the cash flows resulting from a lease transaction. To compare this rate with a loan interest rate, a company must include in the cash flows any effect the transactions have on federal tax liabilities.

Fair Market Value Purchase Option: An option to purchase leased property at the end of the lease term at its then fair market value. The lessor does not have the ability to retain title to the equipment if the lessee chooses to exercise the purchase option.

FASB 13: Statement issued by the Financial Accounting Standards Board establishing financial accounting standards for lessees and lessors.

Financial Statements: Accounting statements that provide specific information about a company's financial position. They include the Profit & Loss Statement, also know as the Income Statement, the Balance Sheet, and the Statement of Cash Flows. Financial statements can generally be audited by an outside CPA firm or be unaudited and, thus, prepared by the company.

Financing Statement (UCC-1): A standardized form recorded with the Secretary of State and/or County Clerk to perfect a lien under the Uniform Commercial Code by notification to all interested parties. Used with some financing leases to protect lessor's interest in the equipment.

Finance Lease: 1) 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. 2) An alternative definition is found in the Uniform Commercial Code, Article 2A, to designate a lease from a non-vendor lessor who acts solely as a funding source and does not deal directly in the equipment.

Floating Rental Rate: Rental which is subject to upward or downward adjustments during the lease term. If the prime interest rate changes during the term of the lease, the rental rate may change to reflect this.

Full Payout Lease: A lease in which the cash flows will return to the lessor the acquisition cost of the asset, the cost of financing, overhead and an acceptable return on investment.

Guideline Lease: A tax lease written under criteria or "guidelines" established by the IRS to determine the availability of key tax benefits to the lessor.

Interim Rent: Interim rent is a one-time daily rental charge for a period of time between the day the equipment is delivered/accepted and the first invoice date. It is a partial payment for using the equipment during a partial month, and will be billed to the lessee on the first invoice.

Investment Grade Credit: Generally refers to a lessee of high credit standing. Technically, an investment grade credit is a company rated highly by one of many recognized credit agencies such as Standard & Poor's.

Lease: A contract in which one party conveys the use of an asset to another party for a specific period of time at a predetermined rate.

Lease Rate (Monthly Payment): The periodic payment to a lessor for the use of assets.

Lease Rate Factor: Numerical factor multiplied by total cost of equipment to compute periodic rentals.

Lease Term: The fixed term of the lease.

Leasing: Leasing is a tax oriented method of gaining the use of an asset that can produce more income or benefits than the cost. A lease can be a method by which a client can obtain either use and/or ownership of an asset while matching a payment schedule to a predetermined budgetary allotment.

Leasing Line: A maximum amount of funding designated by the lessor for a lessee to use over a fixed commitment period.

Lessee: A party who makes use of property owned by another party (the lessor) and pays the lessor, usually in the form of rentals, for that use.

Lessor: Company or leasing entity that is the owner of the leased equipment for accounting, tax, or commercial law purposes.

Level Payments: Equal periodic payments over the term of the lease.

Leveraged Lease: In this type of tax lease, the lessor provides and equity portion (usually 20 to 40%) of the equipment cost and lenders provide the balance on a non-recourse debt basis. The lessor receives the tax benefits of ownership.

Long Term Lenders: Term typically used to describe the institutional lenders supplying debt (up to 80% of equipment cost) for leverage leases. Lenders receive no tax benefits from the lease but receive a fixed rate over a long term.

Master Lease: A contract where the lessee leases currently needed assets and is able to acquire other assets under the same basic terms and conditions without negotiating a new contract.

Middle Market: A market segment generally represented by financing under $3 million and dominated by single investor leases.

Municipal Lease: A municipal Lease is a contract entered into by a state or local government such as a county, city, town or municipal authority.

Net Lease: A lease where payments paid to the lessor do not include insurance, taxes and maintenance, which are paid separately by the lessee.

Non-Payout Lease: A lease in which the cash flows will not be sufficient to cover the full costs of the equipment, the costs of financing, the costs of administration and to provide a satisfactory return. The lessor looks to the residual to realize profit.

Off-Balance Sheet Financing: Unlike the traditional methods of financing, operating lease obligations are not capitalized, thus improving balance sheet ratios. Leases are generally footnoted.

Open-End Lease: (See also Closed -End Lease) A lease which includes a provision for extending payments under the lease on predetermined terms after a set period of time.

Operating Lease: For accounting purposes, an operating lease is any lease which is not a capital lease. These are generally used for short term leases of equipment. The lessee can acquire the use of equipment for just a fraction of the useful life of the asset.

Personal Guaranty: The guarantee of someone to be individually responsible for the obligations under the lease. Generally, when financing closely held subchapter S companies and small businesses, a leasing company may ask for a personal guaranty as a way to insure that the lease payments will be made.

Portfolio Acquisition: The process of purchasing a package of lease contracts and the associated discounted cash flow or remaining payments.

Present Value: The current equivalent value of payments or a stream of payments to be received at various times in the future. The present value will vary with the discount interest factor applied to future payments.

Purchase Option: A provision, assuming the lessee is not in default under the terms of the lease, by which a lessee has the right to purchase the equipment at the end of the lease. The purchase option may be stated at a specific dollar amount or at fair market value.

Put: An option one person has to sell an asset to another person at a set price at some established point in time in the future.  In lease agreements, a lessor sometimes negotiates an option to sell leased equipment to the lessee or to some third party at an established price at the end of the lease term. This is key to protect the lessor's exposure on the residual value of the leased equipment at the end of the lease term.

Recourse Agreement: An agreement with a vendor whereby the vendor will purchase or repurchase the lessor's interest in a lease, usually upon demand, after default of the lessee. Generally, the lease must be in default and a reasonable amount of collection effort exerted by the lessor.

Renewal Option: Lessee's option to renew a lease contract when it ends.

Residual Value: The value of an asset at the conclusion of a lease.

Sale and Leaseback: An arrangement where equipment is purchased by a lessor from the company owning and using it. The lessor then becomes the owner and leases it back to the original owner, who continues to use the equipment.

Security Deposit: An amount of money paid by the lessee at the initiation of a lease. However, the deposit does not reduce the number of payments left on the lease.  Assuming there is no default under the lease,  the deposit is usually returned to the lessee at the end of the lease or applied towards the purchase of the equipment.

Short-Term Lease: Generally referring to operating leases (See also Operating Leases).

Single Investor Lease: (See Full Payout or Finance Lease for comparison). A tax-oriented lease whereby the lessor achieves its desired rate of return via a combination of the rental payments, depreciation, and the fair market value of the equipment at the end of the original lease term. Because of the value of the benefit, the rental payments will be lower than for a finance lease.

Small-Ticket Leasing: Transaction under $100,000 typically using single investor true leases.

Stipulated Loss Value (Insured Value): A schedule included in the lease that states the value of the equipment at key times during the lease, plus its residual value and associated tax benefits, and which establishes the liability of the lessee if the equipment is lost, suffers damage, or becomes unusable during the lease term.

Synthetic Lease: A synthetic lease is basically a financing structured to be treated as a lease for accounting purposes, but as a loan for tax purposes. The structure is used by corporations that are seeking off-balance sheet reporting of their asset based financing, and who can efficiently use the tax benefits of owning the financed asset.

Spread: The difference between funding costs and the rate of return to the lessor on a lease.

Step Lease: A lease where the rent may change during the term of the lease. The change is known at lease inception and is agreed by both the lessor and the lessee. Often a step-up lease allows the lessee to pay less initially and more later in the term.  A Step Down Lease is the opposite.  The lessee pays more initially and the payment amount decreases over the term of the lease.

Tax Lease: A lease where the lessor recognizes the tax incentives provided by the tax laws for its investment and ownership of equipment. Generally, the lease rate factor on tax leases is reduced to reflect the lessor's recognition of this tax incentive.

Term: The length of time a lease agreement will remain in force. The rules of an agreement as supplied on a rental or lease contract between the customer (lessee) and the lessor. The terms of the contract will govern such things as the length of the agreement, rules of proper cancellation of the agreement, renewal terms, and charges for breech of the contract.

True Lease: A type of lease under which ownership of the equipment remains with the lessor. To qualify as a true lease for tax purposes, the Internal Revenue Service states that: 1) Title must remain with the lessor; 2) The rental payments must be competitive with industry rates, represent payment for use of the equipment and have a rate that does not vary appreciably with or without purchase option; 3) The option to purchase price must not be less than the fair market price at the lease's expiration date; 4) Equity cannot be allowed on rental payments. Key for tax purposes, the total monthly payments can be deducted.

Uniform Commercial Code (UCC): A statutory program under the law of administering, legalizing, and recording contracts and lien instruments.

Use Tax: Many states charge a "use" tax in lieu of a sales tax when equipment is leased. So instead of paying a sales tax for purchase of the leased equipment, taxes are collected by the lessor as a percentage of the rentals over the lease term.

Useful Life (Economic Life): The period of time during which an asset will have economic value and be usable. Useful life of an asset is sometimes called the economic life of the asset.

Vendor: A entity that provides leased property to customers.

Vendor Leasing: A working relationship between a leasing company and a vendor to provide financing programs to stimulate the vendor's sales.