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| Terminology |
Operating Leases
An Operating Lease is a lease or usage agreement that allows the Lessee to acquire use of an asset for a fraction of the asset's useful life. This type of lease is accounted for by the Lessee without showing the asset or a liability (for the lease payment obligations) on his balance sheet. Also, the Lessee accounts for rental payments as operating expenses. To qualify as an operating lease for accounting purposes, the following criteria must be met:
- The present value of the minimum lease payments is equal to less than 90% of the fair value of the asset at the inception of the lease.
- The lease term is equal to less than 75% of the useful life of the asset.
- The lease does not contain a bargain purchase option.
- Ownership of the asset does not automatically transfer to the lessee at the end of the lease term.
TRAC Leases
A TRAC Lease is a True Lease with a Terminal Rental Adjustment Clause. For eligible equipment types, the Financial Institution and the Lessee are able to establish a pre-determined end-of-term equipment value. At the end of the lease, if the equipment sells for more than the established amount, the lessee is entitled to a rebate, but if the equipment sells for less than the amount previously agreed upon, the Lessee will owe additional rental charges to The Financial Institution. The inherent benefits of a True Lease exist with the TRAC Lease
Loans
A Loan can be used for financing new or used equipment or refinancing current debt, which can free up cash for working capital. Loans are ideal for customers who need to accumulate tax benefits associated with ownership to reduce federal tax liability. Also with the Loan, the customer is able to accumulate equity in the equipment with the payment of each installment
Synthetic Leases
A Synthetic Lease is a type of off-balance sheet financing that allows a business to receive ownership of tax benefits without incurring debt on its balance sheet for accounting purposes. Thus, the Synthetic Lease is treated as a Loan for federal tax purposes, though as an Operating Lease for financial reporting.
True Leases
A True Lease is one in which the Lessor is owner of the equipment for tax and title purposes, and the lessee is able to claim rental payments as tax deductions. The True Lease is ideal for businesses that are interested in obtaining a lower after-tax cost of capital rather than having the tax benefits associated with equipment ownership to shelter their federal tax liability.
Capital Leases
This refers to a lease in which the equipment is treated as an asset by the Lessee. A capital lease is defined as meeting at least one of the criteria outlined as follows:
- title passes automatically by the end of the lease term
- lease contains a bargain purchase option
- lease term is greater than 75% of the estimated economic life of the equipment
- present value of lease payments is greater than 90% of the equipment's fair market value
A capital lease is treated by a lessee as both a borrowing of funds and the acquisition of an asset and corresponding liability (lease payable). Periodic lessee expenses consist of interest on the debt and depreciation of the asset.
Certificate of Delivery & Acceptance
This is the document that is signed by the lessee to acknowledge that their equipment has been received and is acceptable. The lease commences once this document has been signed
Depreciation
A tax deduction representing a reasonable allowance for exhaustion, wear and tear, an obsolescence, that is taken by the owner of the equipment and by which the cost of the equipment is allocated over time.
Early Termination
Occurs when equipment is returned to the Lessor prior to the end of the lease term. This must be approved by the Lessor and may result in a penalty to the Lessee.
End-of-Term Options
Options stated in the lease paperwork that gives a Lessee flexibility in regard to ownership at lease end. These options will also affect the way in which the Lessee accounts for the lease payments during the lease term. Common options include purchasing the equipment, renewing the lease, or returning the equipment to the Lessor.
Equipment Schedule
A document incorporated by reference into the lease agreement that describes in detail the equipment being leased.
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.
Fair Market Value Lease
A lease which 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.
Fixed Purchase Option
This is an option given to a lessee to purchase their equipment from the Lessor on an option date (typically lease end) for a guaranteed price. This amount is determined at the inception of the lease.
Full Payout Lease
Typically exemplified through a $1.00 Buy Out Lease, this refers to a 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 residual value.
Lease
A contact through which an owner of equipment (Lessor) conveys the right to use its equipment to another party (Lessee) for a specified period of time (the lease term) for specified periodic payments.
Lease Schedule
A schedule to a Master Lease Agreement describing the leased equipment, rentals and other terms applicable to the equipment.
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.
Off Balance Sheet Financing
This refers to the types of leases that qualify for operating leases. Such leases are excluded from the balance sheet asset and debt presentation, except for that portion of the payments that is due in the current fiscal period.
One Dollar [$1.00] Buyout Lease
A common term for a full payout lease.
Purchase Option
An option given to the lessee to purchase the equipment from the Lessor, usually as of a specified date.
Residual Value
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.
PPSA Financing Statement
A document, under the PPSA, filed with the province to provide public notice of a security interest in personal property.
Upgrade
This option, which may be offered, refers to a Lessee's ability to trade in leased equipment for newer, more advanced equipment during the lease
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