Accelerated Cost Recovery System (ACRS)(Modified)
The Tax Reform Act of 1986 established the modified ACRS tax appreciation system 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.
When leased Equipment is delivered and installed, the Lessee typically authorizes the Lessor, in writing, to pay for it. The Lessee’s authorization to pay the supplier is indicated on an Equipment Acceptance Certificate form.
Advance Lease Payments
Many leasing transactions call for one or more payments in advance. As a rule, when Advance Payments are required for more than the just first periodic payment, the additional Advances will apply to payments due at the end of the Lease. If payments are made Monthly, for example, one Advance will apply to the first month’s payment while any additional advances will be applied to payments due at the end of the lease term. Advance Payments are payable at, or prior to, lease inception.
Advance Rental Payments
The payment or payments made at the inception of the lease agreement (i.e. the first rental payment or first and last rental payment.)
Most Lessors use a “Lease Application” form to list the information required to evaluate a prospective Lessee’s credit condition and history.
Additional Lease Application Information
Today, for equipment costing more than $50,000, Accountant Prepared Financial Statements or Federal Income Tax Returns will more than likely be needed. At times, the Principal’s Personal Financial Statement, and/or Bank Reference may also be required.
Credit criteria and financial information requirements vary and are individually established by Lessors in their own discretion.
“Application-Only” Credit Review
Today, some Lessors grant credit using only the information submitted to them on Leasing Applications. This data, along with inputs from Bank and Trade References and independent Credit Bureau Reports, is used to review credit up to certain Transaction Size limits (most often $50,000 to $75,000). For these Lessors, decision-making is generally aided by the use of “Credit Scoring” systems (See “Credit Scoring”) and written Financial Statements are not required from the applicant.
Assignment of Proceeds
Under an Assignment of Proceeds agreement, the vendor agrees to allow the Lessor to fund the manufacturer’s cost of the equipment directly to the manufacturer at the time of funding.
A company or person who arranges transactions between lessees and lessors of an asset.
Most businesses use “Budgets” to forecast and allocate expenditures for specific periods of time. Typically, Capital Budgets include allocations for Equipment acquisitions, while Operating Budgets apply to the periodic expenses incurred in running a business. Often, when Capital Budgets are exhausted, or have been allocated for other purposes, businesses can use available funds from Operating Budgets to Lease needed equipment. Since Leasing Payments are made periodically (i.e. Monthly, Quarterly, or Yearly) and are small in comparison to the full outlay of the Equipment’s Purchase Price, businesses’ can “stretch” their equipment acquisition power by Leasing.
Cash flow is a critical measure of a businesses’ ability to meet Lease obligations. Cash flow is calculated by adding the businesses’ “Net Income” to its “Depreciation Expense” for a particular period (i.e. Month, Quarter, Year), and subtracting the “Current Portion of Long Term Debt”. The remainder of this formulation is the available cash to “service” new lease obligations.
Certificate Of Acceptance (Delivery and Acceptance)
A document whereby the lessee acknowledges that the equipment to be leased has been delivered, is acceptable, and has been manufactured or constructed according to specifications.
A deposit required by the Lessor at time of signing which ranges from 1-2% of the total equipment cost, or the equivalent of the first rental payment. It is generally applied to rental on a pro rata basis if the commitment is taken down or returned if the lease is declined.
The letter prepared by the Lessor to spell out terms and conditions between Lessee and Lessor for a master lease line of credit.
Credit Scoring systems typically formulate values assigned to various credit criteria to create a “Pass/Fail” scoring “Model”. Leasing applicant’s scores are then compared to appropriate Models to determine credit acceptability. Credit Scoring Models are generally derived from the particular Lessor’s historical portfolio performance with Lessee’s of similar Type, Organizational Structure, Credit History, Size, Age, and Credit Bureau Rating, along with such other criteria as individual Lessor’s choose to include. Lessor’s Equipment preferences ordinarily result from that Lessor’s particular experience, or inexperience, with various equipment types. Scoring criteria may vary, predicated on Transaction Size, Type of Business, and Individual Lessor’s particular preferences.
Dealer Lease Referral Application and Agreement
This one page agreement provides the Lessor with valuable information about the equipment vendor. By means of this agreement, the vendor agrees to pass clear title to the equipment to the Lessor upon delivery, acceptance by the Lessee and funding by the Lessor.
Electronic Funds Transfer (EFT – also known as ACH)
A wire transfer in which the Lessor pays the equipment vendor. At time of funding this amount is wired to the vendor minus any payments agreed upon in the Assignment of Proceeds.
Fair Market Value (FMV)
The open market value of the asset at the termination of the lease. A Purchase Option under a True Lease is generally the Fair Market Value at the end of the lease.
Fair Market Renewal Value
The rental payment paid monthly for a period of up to one year if the Lessee elects to renew the lease once it has initially terminated. The value is determined by negotiation between Lessee and Lessor and represents the Fair Market Rental/Renewal Value.
A financing device whereby a Lessee can acquire title to the asset for a nominal amount or a guaranteed purchase amount. For tax purposes this form of lease is usually considered a conditional sales contract. Generally, a Finance Lease is non-cancelable during the term of the lease; and the end-user is responsible for maintenance, taxes, insurance and other costs of ownership.
Full Payout Lease
A lease in which the cash flows will pay the Lessor the full equipment cost plus an agreed upon return over the lease term.
At times, business Owners (especially in the case of Proprietorships, Partnerships, closely-held Corporations, or Small Businesses), may be required to personally guarantee a leasing transaction. In these cases, the appropriate party(s) will acknowledge his or her Guarantee on a separate Guaranty form, or in a separate Guaranty section of the Lease Agreement itself. At other times, a business may be a subsidiary of, or owned wholly or in part by, another business. Depending on the circumstances, the Lessee’s “Parent” may be required to guarantee a Leasing transaction.
A document prepared by the Lessor which is signed by the Lessee’s landlord which gives up any rights he may have in the leased equipment at the Lessee’s place of business. This waiver allows the Lessor to remove the equipment in case of default or at end of lease. It also protects the Lessor in cases where leased equipment is attached to real property.
An agreement granting or letting the possession of land, building, machinery, personal property, etc., for a fixed or indeterminate period, for a stated consideration usually known as rent.
The Lease Commencement Date is the date equipment is accepted by the Lessee as evidenced by Lessee’s execution of an Acceptance Certificate.
A written agreement between the Lessor and Lessee that outlines the basic terms and conditions of a specific lease transaction. Both parties sign this proposal, and it is subject to credit approval.
The simple equivalent interest rate excluding depreciation and residual, if any.
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.
Company or leasing entity that is legal owner of the leased equipment.
Equal payments over the term of the Lease.
An open-ended lease agreement under which a Lessee obtains the use of specific property and can add additional equipment periodically. Eliminates signing new leases as additional equipment is leased.
With a Net Lease, the rentals are payable to the Lessor. All costs in connection with the use of the equipment are to be paid by the Lessee and are not a part of the rental. For example, taxes, insurance, and maintenance are paid directly by the Lessee.
Many vendors require that they be paid at least 50% of the invoice amount once the lease is funded. This is called prefunding. It must be approved by the funding source. For Pre-Funding to be accepted, both the vendor and lessee must be stable for acceptance.
Most Purchase Options are drafted on separate forms. Purchase Option forms may state a specific purchase price or percentage of equipment cost to be paid, the terms and conditions for Purchase Option exercise and any other provisions, such as the method employed for discrimination of “Fair Market Value” (if applicable), established by the Lessor.
A Security Deposit is an advance payment that is usually equal to two lease payments,. This deposit is retained by the Lessor for the term of the Lease. If the lease is never finalized for reasons that are not the fault of the Lessor, the deposit will be kept by the Lessor for administrative costs. If any part of the deposit is remaining at the end of the Lease term and the Lessee has completed all of his / her obligations, the Deposit is returned to the Lessee or can be applied to the Purchase Option, if any, or to any remaining payments.
Freight, software, labor and other intangible items are frequently defined as soft costs. Many funding sources will only allow a certain percentage of the total transaction to be soft costs. Because these costs can generally not be recovered in case of default, they increase the inherent risk of the lease.
A True Lease is a transaction that qualifies as a lease under the Internal Revenue Code. This lease functions so that the Lessee can claim rental payments as tax deductions and the Lessor can claim tax benefits of ownership such as depreciation.
Uniform Commercial Code (see Financing Statement – UCC1)
A standardized program and method of administering, legalizing and recording lien instruments adopted now by all states except Louisiana.
The period of time during which an asset will be usable and have some economic value. 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 life of at least one year.
Many states have passed laws that limit the interest rate that can be charged on loans. These laws are called “Usury Laws”. In states such as Texas, Arkansas, Florida and Nebraska, $1.00 buyout leases are also subject to Usury and, as such, leasing companies have either refused to write such leases in these states or require certain addendums or additional documentation.