Leasing is a flexible and creative method of acquiring equipment and vehicles. In order to maximize the benefits of leasing, you need to have a good understanding of the basics. Knowledge of the related terms and issues will assist you in evaluating leasing options. We hope you will find this glossary a valuable guide to finding the best financing solution for your business.
Features and enhancements that may be installed on lease equipment.
One or more lease payments required to be paid to the lessor at the beginning of the lease term. Lease structures commonly require one payment to be made in advance. This term also refers to leasing arrangements in which the lease payment is due at the beginning of each period.
A.P.R. (Annual Percentage Rate) is the effective rate taking into account compounding and other fees. The nominal rate of interest for a specified period (usually one year).
The amount a lessee must pay the lessor to terminate a lease early. Usually calculated to include tax recaptures, unpaid personal property taxes and lost revenues.
Capped Fair Market Value Lease
A Fair Market Value Lease with a predetermined ceiling to limit Fair Market exposure at the end of the lease term.
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. Also refers to a vehicle lease in which the lessor absorbs the entire risk of the residual (closed ended lease).
Banks and suppliers used in the lessee’s business and listed on the lease application. Lessor may contact them to check lessee payment histories.
An objective method of quantifying credit worthiness by assigning numerical values based on meeting established credit criteria.
A means for a firm to recover the cost of a purchased asset, over time, through periodic deductions or offsets to income. Depreciation is used in both a financial reporting or tax context, and is considered a tax benefit because the depreciation deductions cause a reduction in taxable income, thereby lowering a firm’s tax liability.
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 todays, dollars. Use of a discount rate removes the time value of money from future cash flows.
This event 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. The early payoff related to an upgrade is generally discounted.
Fair Market Value (FMV)
The fair market value (FMV) is the price equipment or vehicles will sell for at a neutral sale event from a willing seller and buyer.
A lease used to finance the purchase of equipment is 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.
Financial Accounting Standards Board 13 (FASB 13)
FASB 13 (“Accounting for Leases”), along with its various amendments and interpretations, specifies the proper classification, accounting and reporting of leases by lessors and lessees.
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.
A charge for the use of a piece of equipment from its in-service date, or delivery date, until the date on which the base term of the lease commences. The daily interim rent charge is typically equal to the daily equivalent of the base term commencement date for a lease agreement having multiple deliveries of equipment.
A contract through which an owner of equipment (the lessor) conveys the right to use its equipment to another party (the lessee) for a specified period of time (the lease term) for specified periodic payments.
An entity which provides one or more services in the lease transaction, but does not retain the lease transaction for its own portfolio. Such services include finding the lessee, working with the equipment manufacturer, securing debt financing for the lessee to use in purchasing the equipment and locating the ultimate lessor or financial source in the lease transaction. The lease broker also is referred to as a packager. Brokers are paid fees for finding a lender and the charge is included in the lease rate. Madison is a direct lender not a broker.
An addendum to a Master Lease agreement describing the leased equipment, rentals and other terms applicable to the equipment.
The user of the equipment being leased.
The owner of equipment leased to a lessee or user. (Legal title under the Uniform Commercial Code may be with the lessee in finance leases and nontax leases.)
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. To be contrasted with 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.
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 payments is less than 90% of the equipment’s fair market value
- lease cannot contain a bargain purchase option (i.e., less than the fair market value)
ownership is retained by the lessor during and after the lease term – No bargain purchase price at the lease end.
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 Advance
Periodic payments are due at the beginning of each period.
Payment in Arrears
Periodic payments are due at the end of each period.
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.
An option given to the lessee to purchase the equipment from the lessor, usually as of a specified date.
The value of the equipment or vehicle at the and of the lease term.
A transaction involving the sale of equipment to a leasing company and a subsequent lease of the same equipment back to the original owner, who continues to use the equipment. A way for a business to raise capital by pledging equipment equity.
Step-up or Step-down
A feature of a lease containing a payment stream that either increases (step-up) or decreases (step-down) in payment amount over the lease term.
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.
Uniform Commercial Code (UCC)
A set of standard rules, adopted by 49 states, that governs commercial transactions.
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. 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 leased property at the end of the lease term, and at least a life of one year.
To trade in leased equipment for a newer, more advanced model during the lease term.