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.
Note: Under certain circumstances, lease agreements can be structured that call for "Payment in Arrears". In this case, no advance payments will be required at lease inception, and lease payments are payable at the end of each lease period during the term.
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 Principals 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.
Tip: Leasing Applicants and Equipment Vendors will get the fastest credit responses if Leasing Applications are filled out completely, accurately, and legibly
Benefits of Equipment Leasing:
Equipment leasing conserves working capital
Equipment leasing provides 100% financing for equipment acquisitions
Equipment leasing keeps existing bank and other lines of credit open
Equipment leasing provides an Additional line-of-Credit for equipment acquisitions
Equipment leasing helps to overcome budget restrictions and limitations
Equipment leasing helps to maximize cash-flow
Equipment leasing does not require down-payments
Equipment leasing may provide tax savings
Equipment leasing may provide off-balance-sheet financing
Equipment leasing provides specific equipment, chosen by the Lessee
Equipment leasing provides equipment acquired from suppliers chosen by the Lessee
Equipment leasing protects against operating obsolete equipment
Equipment leasing hedges against inflation
Equipment leasing is flexible financing that can be matched to specific customer needs
Equipment leasing makes a few cents work like dollars
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.
Common Equipment Lease Types:
The two most popular lease types are Finance Leases and True Leases.
* Finance Leases generally call for the "Full-Pay-Out" of the total equipment cost and financing charges over the original lease term. These Leases ordinarily include a fixed Purchase Option (I.e. $1.00 or a fixed percentage of equipment cost.) Since the end-of-term purchase price is predetermined, Finance Leases may not meet the requirements for tax deductibility or for "Off-Balance Sheet" accounting treatment.
* True Leases do not call for full-pay-out of the equipment cost and financing charges during the original lease term. Typically, Lessees receive either no option or, at most, an FMV option to purchase the equipment. Since True Leases intend to provide only equipment usage, and don't include predetermined Purchase Option prices, Lessees often classify True Lease payments as operating expenses, thereby gaining any available Tax Benefits. Because the Lease Term; Lease Payment; Equipment's Estimated Useful Life; Leasing Rate; and Lessee's potential of equity in the Equipment can effect the Lessee's Accounting and Tax treatment regarding any particular Leasing Transaction, it's strongly suggested that the Lessee seek competent Tax and Accounting advice.
* Operating Leases: Some True Leases are known as "Operating Leases" because the Lessee can classify the lease payments as operating expenses on its "Income Statement". Truly leased equipment does not necessarily appear on the Lessee's "Balance Sheet" as an owned asset, nor do the corresponding lease payments appear on the Lessee's Balance Sheet as fixed debt.
Corporate Resolution/Certificate of Secretary:
A Corporation must attest that the Individual executing a Lease Agreement on its behalf is duly authorized to do so. A Signatory's authority is commonly confirmed by the execution of a "Corporate Resolution" or " Certificate of Secretary". On this form, the Corporate Secretary, or other authorized officer, attests that the signatory is empowered, by name or title, to execute Lease Agreements for the Lessee. The Lessee's "Corporate Seal" is ordinarily required to be affixed to these forms, as well. As a rule, the requirement of a Resolution or Certificate depends on the Equipment Cost, Type of Lease, and the particular policies of individual Lessors. Most Leasing Transactions covering equipment costing less than $25,000 do not require this document.
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 vary, predicated on Transaction Size, Type of Business, and Individual Lessor's particular preferences.
Documentation (Leasing Agreements and Paperwork):
Leasing terms and conditions are set out in written Lease Agreements, sometimes comprising several different forms. Documentation requirements vary, depending on the Type of Lease; Equipment; Equipment Cost; Number of Units Leased; Equipment Configuration; Additional Provisions (if any); and the particular contractual policies of individual Lessors. For example, Small Ticket Lessors today commonly use One Page, self-contained, Leasing Agreement forms while more expensive equipment generally calls for more extensive contracts.
Leases do not require "Down-Payments". Conditional Sales Contracts, Chattel Mortgages, Bank Loans, and other types of equipment based financing frequently require the borrower to pay 10 to 25 percent of the purchase price at the outset.
Economic Life (Useful Life)
The period of time during which an asset will have economic value and be usable.
Most Lessors require the Lessee to insure the equipment against casualty loss, all risks, and require that Lessee indemnify the Lessor against any liability incurred from the possession, operation, or usage of the equipment.
An equipment lease is a transaction when a "Lessor" owns particular equipment and agrees to permit a "Lessee" to use it. Lease terms typically cover one to eight or more year periods, depending upon the specific equipment's type and usage. Lessors ordinarily offer Monthly, Quarterly, Semi-Annual, or Annual payment scheduling, where applicable. Individualized payment structures can often be tailored to meet particular Lessee's cash-flow, or other financial requirements. Lease Agreements can often provide for the Lessee's purchase of the equipment at the end of the original lease term. Most often, the Lessee will select the specific equipment to be leased and choose a vendor from whom that equipment will be purchased. The Lessor will then purchase the equipment on the Lessee's behalf.
Equipment Supplier (Vendor):
The "Equipment Supplier" is the Vendor of the equipment to be leased.
Fair Market Purchase Option:
An option to purchase leased property at the end of the lease term at its then fair market value. The lessor does not have the ability to retain title to the equipment if the lessee chooses to exercise the purchase option.
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.
The Agreement itself is, most often, a pre-printed form that contains the basic Leasing "K&s and Conditions", including: the Equipment Location and Usage conditions, Equipment Insurance requirements, responsibility for Taxes and Fees, Default provisions, Late Payment provisions, remedies, Lessor's Assignment rights, Equipment Return provisions, Indemnity, Title to the equipment, and such other or Additional Provisions as determined by the Lessor and by law. The Lease Agreement also calls for input of the exact legal name and address of the Lessor and Lessee; a specific Description of the Equipment Leased; the Name and Address of the Equipment Supplier; a Schedule listing the Term of the Lease, the Number and Timing of Lease Payments, the Amount of each Lease Payment, any Applicable Taxes payable, the Number of Advance Lease Payments required; and any Additional Fees or Costs to be paid by the Leasee.
Most Lease Agreements call for a fixed percentage payment for a fixed period of time. To simplify leasing payment calculation, leasing rates are typically stated as the number of dollars ($'s) charged per thousand dollars ($'s) of equipment cost leased, per specific period of time. The percentage equipment cost leased per period of time is commonly known as a "Rate Factor" Once the appropriate Rate Factor has been calculated, any applicable equipment cost can then be multiplied by that Rate Factor to derive the lease payment. For example, in a Five Year (60 month) Lease that calls for a lease charge of $24.00 per $1000 per month, the Rate Factor equates to .024. To determine the payment for equipment costing $25,000: Multiply $25,000 X .024 = $600 per month. Leasing Rate Factors are based on various criteria such as: The then current Money Market costs; Lease Term, Equipment Cost, Purchase Option alternatives, Lease Type, and any other variables applicable to particular lease configurations
"Leverage" commonly applies to the amount of a businesses' Debt compared to intangible Net Worth or Stockholder's Equity.
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.
Purchase Option Alternatives:
Most often, leases provide an option for the Lessee to purchase the equipment at the end of the lease term. The most common Purchase Options are:
* $1.00 Purchase Option: Permits purchase of the equipment at the end of the original lease term for $1.00.
* Fixed Purchase Option: Permits purchase of the equipment at the end of the original lease term for a fixed percentage of its original cost. Typically option prices equal 5, 10, 15, or other percentage of equipment cost.
* Fair Market Value Purchase Option: Permits purchase of the equipment at the end of the original lease term for its fair market value. FMV is determined at lease expiration by recognized appraisers or similar experts in the specific equipment.
* Prepaid Purchase Option: Calls for payment of the Purchase Option or before, Lease inception.
Most leased equipment has a remaining or resale value at the end of the original lease term. The remaining value is referred to as the Residual.
An arrangement whereby leased equipment is purchased by a lessor from the company owning and using it. The lessor then becomes the owner and leases it back to the original owner, who continues to use the equipment.
Similar to Advance Lease Payments, Security Deposits are paid at, or prior to, lease inception. Security Deposits protect the Lessor by offsetting losses due to: Unreasonable wear and tear to returned equipment; the non-return of equipment; or any other costs incurred due to the Lessee's actions of negligence.
Uniform Commercial Code Financing Statements (UCC1):
Standardized UCC1 forms are commonly used by Lessors to secure their ownership of leased equipment. UCC1's are filed with the Secretary of State's office, (and in some cases the County Clerk's office), of the State (and County, if applicable) where leased equipment is located. The purpose of filing these forms is to notify other parties who may seek a security or other interest in the specific equipment, that a particular party currently has a secured interest in the identified equipment.
Vendor (Equipment Supplier):
The Vendor is the Seller of the equipment to be leased.