 Glossary of TermsAdvance PaymentsPayments made by the lessee at the inception of a financing transaction. AmortizationA breakdown of periodic loan payments into two components: a principal portion and a interest portion. Capital LeaseA 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 for determination of a capital lease follow:
A capital lease is treated by the lessee as both the borrowing of funds and the acquisition of an asset to be depreciated. Thus, 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. CoterminousTwo or more leases that are linked so both (all) terminate at the same time. DepreciationA tax deduction representing a reasonable allowance for equipment exhaustion, wear and tear, and obsolescence, taken by the equipment owner and by which the cost of the equipment is allocated over time. Depreciation decreases a company’s balance sheet assets and is also recorded as an operating expense for each period. Various methods of depreciation are used that after the number of periods over which the cost is allocated and the amount expensed each period. Discount RateA certain interest rate used to bring a series of future cash flows to their present value to state them in current dollars. Use of a discount rate removes the time value of money from future cash flows. Estimated Useful LifeThe period which an asset is expected to be useful in trade or business. Estimated Useful Life is:
The price for which property can be sold in an “arms length” transaction between unrelated and willing parties, each of which is acting rationally and in its best interest. Fair Market Value LeaseA lease that includes an option for the lessee to either renew the lease at a fair market value renewal or purchase the equipment for its fair market value at the end of the lease term. Though often referred to as a tax lease, not all fair market value leases qualify as tax leases. Finance LeaseA lease used to finance the purchase of equipment; not a true lease. Finance leases are generally considered to be capital leases from a tax perspective. FASB 13Statement number 13 of the Financial Accounting Standards Board (FASB) which 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 purpose. A company’s assets, liabilities, and net income will differ depending on how it chooses to structure it 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). Full Payout LeaseA lease in which the total of the lease payments pays back to the lessor the entire cost of the equipment including financing, overhead, and a reasonable rate of return, with little or no dependence on a residual value. LeaseA contract through which an owner of equipment (the lessor) conveys the right to use its equipment to another party (the lessee) for a specific period of time (the lease term) for specified periodic payments. Lease PurchaseFull payout, net lease structured with a term equal to the equipment’s estimated useful life. Because many 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 generally considered to be capital leases from an accounting perspective and nontax leases from a tax perspective due to their bargain purchase option and length of lease term. Lease ScheduleA schedule to a master lease agreement describing the leased equipment, rentals, and other terms applicable to the equipment. LesseeThe party to 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. LessorThe 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 LeaseA 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. Off Balance Sheet FinancingA 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 LeaseA lease that 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:
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 AdvancePeriodic payments are due at the beginning of each period. Payments in ArrearsPeriodic payments are due at the end of each period Present ValueThe 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 OptionAn option given to the lessee to purchase the equipment for the lessor, usually as of a specified date. Residual ValueThe book value that the lessor depreciates a piece of equipment down during the lease term, typically based on an estimate of the future value, less a safety margin. Sale-LeasebackA transaction that involves the sale of equipment to a lease / finance 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 LeaseA 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 LeaseA 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. Useful LifeThe period of time during which an asset will have economic value and will 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% of the original estimated useful life of the leased property at the end of the lease term, and at lease a life of one year. UpgradeTo trade in leased equipment for a newer, more advanced model during the lease term.
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