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Financing Glossary

Add-On
A transaction to add related equipment (usually equipment upgrades) to an existing lease. The lease term for the add-on is set so that it expires co-terminously with (on the same date as) the original transaction.

Advance Payments
Payments made by the lessee at the inception of a leasing transaction.

Amortization
A breakdown of periodic loan payments into two components: a principal portion and an interest portion.

APR
Annual Percentage Rate. The effective rate taking into account compounding and other fees. The nominal rate of interest for a specified period (usually one year). The APR can be calculated given the term of the lease agreement, the monthly rate factor, the future value and present value.

Bargain Purchase Option
An option given to the lessee to purchase the equipment on lease at a price that is far lower than the expected fair market value so that, at the inception of the lease, it is reasonable to assume that the lessee will definitely purchase the equipment on the option date. Purchase options are subject to local legislation and accounting rules.

Capital Lease
A lease that meets at least one of the criteria outlined in paragraph 7 of FASB 13 and, therefore, must be treated essentially as a loan for book accounting purposes. The four criteria are:

Title passes automatically by the end of the lease term
Lease contains a bargain purchase option (i.e., far lower than the fair market value)
Lease term is greater than 75% of estimated economic life of the equipment
Present value of lease payments is greater than 90% of the equipment's fair market value

The lease is recorded on the lessee's balance sheet as an asset and corresponding liability (lease payable). Periodic lessee expenses consist of interest on the debt and depreciation of the asset.

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 this document has been signed.

Compensating Balances
The amount of funds that a bank requires a borrower to keep on deposit during the term of a loan. The amount of this non-interest earning deposit is typically based upon some percentage of the loan and effectively increases the borrower's interest cost.

Conditional Sales Contract
The Seller sells the asset and transfers possession to the Purchaser, but retains title to the asset until the Purchaser has fully paid for it. In other words, a contract for a sale where the customer pays for his purchase in installment payments rather than all at once.

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.

Coterminous
Two or more leases that are linked so that both will terminate at the same time.

Depreciation
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 and tax content, and is considered a tax benefit because the depreciation deductions cause a reduction in taxable income, thereby lowering the firm's tax liability. Types of Depreciation include Straight Line, Sum of Years Digits, Declining Balance, Double Declining Balance.

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. Use of a discount rate removes the time value of money from future cash flows.

Equipment Schedule
A document incorporated by reference into the lease agreement that describes in detail the equipment being leased. The schedule may state the lease term, commencement date, repayment schedule and location of the equipment.

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 end-of-term options include purchasing the equipment, renewing the lease or returning the equipment to the lessor. Purchase options are subject to local legislation and accounting rules.

Estimated Useful Life
The period during which an asset is expected to be useful in trade or business:

Used for purposes of calculating the maximum allowable term of a tax lease
Used for determining whether or not the lease is a Capital Lease
Used to determine the method of depreciation for a capitalized leased asset
May or may not be the same as the life used for income tax purposes

Fair Market Value
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.

Financial Accounting Standards Board
The rule-making body that establishes financial reporting guidelines.

FASB 13
Statement number 13 of the Financial Accounting Standards Board (FASB) establishes standards for lessees' and lessors' accounting and reporting for leases. This includes the characterization of a lease as an operating lease or capital lease for the lessee's purposes. A company's assets, liabilities and net income will differ depending on how it chooses to structure its leases. The provisions of FASB 13 derive from the view that a lease that transfers substantially all of the benefits and risks of ownership should be accounted for as the acquisition of an asset and the incurrence of an obligation by the lessee (a capital lease) and as a sale or financing by the lessor. Other leases should be accounted for as the rental of property (operating leases).

Finance Lease
A lease used to finance the purchase of equipment; 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.

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. Purchase options are subject to local legislation and accounting rules.

Full Payout Lease
A lease in which the total of the lease payments allows the lessor to recover the entire cost of the equipment including financing, overhead, and a reasonable rate of return, with little or no dependence on a residual value.

Incremental Borrowing Rate
The rate that, at the inception of the lease, the lessee would have incurred to borrow over a similar term the funds necessary to purchase the leased asset.

Lease
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.

Lease Payment
The amount owed per period (typically, monthly) from lessee to lessor. Lease payment is calculated by multiplying the lease rate factor by the amount to finance.

Lease Rate Factor
A Percentage that, when multiplied by the Amount to Finance produces the Rental Payment. Lease rate factor is not equivalent to the interest rate or yield..

Lease Schedule
A schedule to a Master Lease agreement describing the leased equipment, rentals and other terms applicable to the equipment.

Lessee
The party in a lease agreement who is obligated to pay the rentals to the lessor and is entitled to use and possess the leased equipment during the lease term.

Lessor
The party to a lease agreement who has legal or tax title to the equipment (in the case of a true tax lease), grants the lessee the right to use the equipment for the lease term and is entitled to receive the rental payments.

Master Lease
A continuing lease arrangement that allows a lessee to add equipment from time to in a new lease schedule executed by the parties. The original lease contract terms and conditions apply to all subsequent schedules.

Net Present Value
The total discounted value of all of the cash inflows and outflows from a project or investment.

Off-Balance Sheet Financing
Any form of financing, such as an Operating Lease, that, for financial reporting purposes, is not required to be reported on a firm's balance sheet.

Operating Budget
A budget that lists the amount of non-capital goods and services a firm is authorized by management to expend during the operating period.

Operating Lease
From a financial reporting perspective, a lease that has the characteristics of a usage agreement. Such a lease is not required to be shown on the balance sheet of the lessee. The term is also used to refer to leases in which the lessor has taken a significant residual position in the lease pricing and therefore must salvage the equipment for a certain value at the end of the lease term in order to earn its rate of return.

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
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

Payments in Advance
A payment stream in which the lease payment is due at the beginning of each period (e.g., month, quarter) during the lease.

Payments in Arrears
A payment stream in which the lease payment is due at the end of each period (e.g., month, quarter) during the lease.

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.

Purchase Option
An option given to the lessee to purchase the equipment from the lessor, usually as of a specified date. Purchase options are subject to local legislation and accounting rules.

Residual Value
The value, either actual or expected, leased equipment has at the end, or termination, of the lease. The book value that the lessor depreciates a piece of equipment down to during the lease term, typically based on an estimate of the future value, less a safety margin.

ROA: Return on Assets
A common measure of profitability based upon the amount of assets invested; ROA is equal to the ratio of NET INCOME to TOTAL ASSETS.

ROE: Return on Equity
A measure of profitability related to the amount of invested equity. ROE is equal to the ratio of NET INCOME to OWNERS' EQUITY.

Sale-leaseback (SLB)
A transaction that involves the sale of EXISTING equipment to a leasing company and a subsequent lease of the same equipment back to the original owner, who continues to use the equipment.

Step-up or Step-down
A feature of a lease that contains a payment stream that either increases (step-up) or decreases (step-down) in amount over the term of the lease.

Tax Lease
A generic term for a lease, in which the lessor takes on the risks of ownership and, as the owner, is entitled to the benefits of ownership, including tax benefits.

True Lease
Another term for a tax lease where, for IRS purposes, the lessor 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.

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. 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.

Upgrade
An option that allows the lessee to add equipment to an existing piece of equipment in order to increase efficiency or capacity; or, to trade in leased equipment for a newer, more advanced model during the lease term.

Yield
The rate of return to the lessor in a lease investment.