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The Leasing glossary contains definitions, background information and valuable facts and figures about leasing and financing.
Acquisition Costs and Acquisition Value The acquisition costs include the purchase price for the lease object as well as the transportation costs, installation, and packaging costs, if those are not settled directly between the supplier and the lessee. The acquisition costs – often without any incidental costs – are the calculation basis for all leasing payments.
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Accounting according to US-GAAP Regulations US-GAAP regulations comprise the accounting criteria (Accounting) for companies in the USA (including subsidiaries in foreign countries) and for companies, whose shares are to be traded on the New York Stock Exchange. US-GAAP regulations comprise check criteria, according to which it is determined whether leasing investments should be accounted for on the lessor’s or the lessee’s side.
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Adaptation Agreements, Agreement Increases Leased economic goods may be modified or extended during the term of a lease agreement. This applies especially to information and communication technology systems. So-called adaptation agreements are signed for the modifications and increases, whose term will be adapted to the residual term of the master agreements.
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The lessor usually activates the investment object. Thus, the investment does not affect the lessee’s balance sheet, i.e., neither the investment good nor the liabilities are accounted for. The equity ratio and the level of indebtedness do not change. Current leasing expenses are accounted for in the profit-and-loss statement. Leasing obligations are shown in the attachment to annual statements.
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Bankruptcy of the Lessee/Insolvency In case of a payment default the lessor may cancel the lease agreement, accelerate the maturity of reserves and demand the return of the leasing objects. As soon as the insolvency proceedings are opened it is up to the liquidator if and how the lease agreement will be continued. A continuance is only possible if the leasing payments are made.
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Bankruptcy of the Supplier/Insolvency In case of insolvency of the supplier during the warranty period, the warranty risk is transferred to the lessor. Therefore, leasing companies perform a credit check of the supplier before they conclude a lease agreement. In order to avoid such warranty risk, in individual cases, a warranty exclusion is arranged with the lessee. Another variant to avoid warranty risks is a sale-and-leasing-back agreement with the lessee, which stipulates that the lessee purchases the leasing object from the supplier, sells it to the leasing company, and then leases it back.
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Basic Term of Lease Agreements From a fiscal standpoint the non-terminable term of lease agreements is very important. Each lease agreement, which is intended to lead to accounting of the economic good on the lessor’s side, must have a non-terminable basic term of at least 40% and no more than 90% of the usual operational usability (and/or shorter depreciation on asset term in case of multi-usage). These regulations are an essential part of the fiscal leasing decree.
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An international committee of bank regulatory authorities and central banks works in Basel, Switzerland, on new regulations for equity capital requirements for banks. The regulatory committees have the task to make sure that capital requirements for banks with regard to lending are more dependent on the individual risk. Up to now, 8% equity capital was necessary for loans; in the future this percentage will depend on the individual risk (more or less equity capital).For bank customers this means that their individual loan risk is determined by their credit rating which also influences their financing costs. Leasing improves the economic good relations for the lessee, which can have a positive influence on the rating. Leasing companies are not subject to the regulations of Basel II. The new equity capital regulations are expected to be legally binding as of 2006.
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Describes leasing of large projects – such as ships, airplanes, power plants, and real estate.
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Payments becoming due in the future (deposits and payouts) discounted as current value. This allows for a comparison of future payments with different terms, amounts, and due dates. The calculation of cash values has a special meaning in lease agreements according to the regulations IAS/IFRS, and US-GAAP (Cash Value Test).
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Confirmation/Statement of Acceptance By the legally signed Statement of Acceptance the lessee confirms that the supplier has delivered and installed the ordered leasing object completely and in perfect condition as was agreed upon. The object is operational. The acceptance marks the beginning of the term of the lease agreement; i.e., the lessor will pay for the supplier’s invoice and will be the owner of the object. Furthermore, the payment obligations of the lessee in the framework of the lease agreement will commence.
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After a favorable check, the lessee will receive a confirmation of the lease application by the lessor. The leasing company will at the same time become part of the order by the lessee from the supplier.
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Credit rating is the credit-worthiness or the leasing-worthiness. This includes the credit rating of the lessee, the supplier, as well as the maintenance of value of the leasing object. The lessee must have a high credit rating, so that the agreed upon leasing payments can be made for the term of the agreement. The credit rating of the supplier insures that the supplier can fulfill his delivery and warranty obligations. The maintenance of value of an object ensures that the object could be used by a Third Party.
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Cash-Flow is an economic indicator showing all of a company’s liquid assets produced in an accounting period. In simple words, the Cash-Flow consists of the profit plus depreciation plus/minus reserves. Cash-Flow is an important variable to measure a company’s ability to pay back debt as well as its internal financing.
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Leasing across borders. The lessor and the lessee reside in different countries. Complications through different fiscal and accounting framework conditions in various countries.
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The “General Leasing Conditions” regulate the conditions and the extent to which a leased economic good may be used.
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In case the leasing objects get damaged, the lessee must pay to remedy the damage. The damage risk commences with the agreed upon passing of risk.
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Defects, Notice of Defects Upon acceptance of the object the lessee must inspect the delivered object for defects and must immediately issue a notice of defects, if there is any damage. The supplier of the leasing object must repair all defects during the warranty term and must bear all repair costs. The lessee confirms that the faultless acceptance and the identity of the leasing object.
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Degressive Payment Process A degressive payment process describes decreasing payments. In the case of lease agreements, monthly payments are relatively high at the commencement of the lease term, but they decrease in the course of the lease term. Degressive payment processes are arranged to adjust the costs to the wear and tear of leased economic goods, which is usually high in the beginning. The degressive payment process can play an important role for an investment descision, if economic, fiscal, or liquidity requirements are to be optimally fulfilled.
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The lessee and the supplier agree on deposits due before delivery and the start of the lease agreement. The leasing company may make these payments on behalf of the lessee within the framework of a contract. The interest for deposits (prefinancing) will be calculated at the start of the lease agreement and charged to the lessee’s account. If the lessee makes the payment on his own behalf, he acquires expectancy of ownership. In connection with a lease agreement the expectancy will be transferred to the leasing company, so that the leasing company may acquire ownership at all. The leasing company, the lessee, and the supplier agree that the lessee’s deposit is regarded as having been made by the leasing company.
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The interest-rate-based factor by which future receivables (such as future leasing rates) are converted (discounted) to a present value.
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Electronic and Data Insurance A special insurance policy for information and communication technology systems (hardware and software), and for office technology equipment. This insurance covers damages due to: negligence, improper handling, Third Party intent, short-circuit, overload, induction, fire, lightning, explosion or implosion, as well as water damage in case of a fire. Furthermore, the insurance covers damage from water, humidity or floods in buildings, as well as theft from burglary, other theft, robbery, looting, sabotage, as well as acts of God.
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Each lease agreement ends with the return of the object to the leasing company. Before the end of an agreement the Parties discuss whether the agreement should be extended for the continued use of the object, or if the object should be sold to the lessee or a Third Party.There are lease agreements with a fixed end-of-lease term or with automatic extension, which do not require further negotiations.
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Equipment-Leasing is the leasing of machinery and company equipment.
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A final settlement is used for vehicle kilometer contracts. For this purpose the actually driven kilometers are checked against the contractually agreed number of kilometers. Furthermore, the vehicle will be examined with regard to wear-and-tear and damages. For other economic goods the final settlement takes place if the condition of the object is worse than it would have been expected if it had been used in accordance with the contractual usage and maintenance.
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Lease agreements concluded within the framework of the fiscal leasing decree are formally called “Financing Leasing Agreements” (Finanzierungs-Leasing-Verträge) in Germany, although leasing comprises the granting of use of an object and not a traditional financing function.
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The lessor and the lessee enter into a framework agreement for leasing investments planned for a longer period of time (for example, one year). This confirms to the lessee up to which amount he can make investments. This eliminates individual lease agreements for each investment, since lease or call notes are sufficient. A framework agreement allows the lessee to stipulate optimal lease conditions. It also has low administrative costs.
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Lease agreements including further services – especially for technical equipment and automobiles. For example, maintenance and wear-and-tear repairs may be part of the agreement.
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The English term for a fully amortized lease agreement.
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For automobile lease agreements (especially for vehicle fleets) additional service agreements may be made: Depending on the customer, these can include inspections, repair, insurance, taxes, fuel charges, tire replacement, damage handling with insurance companies, and much more.
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The IAS/IFRS (International Accounting Standards/International Financial Reporting Standards) are the European equivalent of the US American accounting regulations, US-GAAP. IAS/IFRS regulations are currently being enhanced. Meanwhile it was decided that all publicly owned firms within the EU must prepare their annual statements according to IAS/IFRS standards beginning with January 1, 2005. Countries outside the EU are also developing national accounting regulations according to IAS/IFRS standards. Due to the fact that the standards have yet to be finalized, it is not certain if annual statements prepared according to IAS/IFRS standards are recognized by the New York Stock Exchange. Therefore, internationally operating German groups currently prepare their annual statements according to US-GAAP standards. It remains to be seen which one of the two accounting regulations will be more important, or if there will be some sort of harmonization between these two regulations. IAS/IFRS standards comprise check criteria, according to which it is determined whether leasing investments should be accounted for on the lessor’s or the lessee’s side.
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During the term of a lease agreement initially the investment risk lies with the lessee. After the return of the object on the regular expiration of the agreement term, or in case of early termination of the agreement, the investment risk (such as the market value risk) is transferred to the lessor.
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An investment good is leasable if it is an independent economic good and is fungible.
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The lease agreement is an agreement between the lessee and the lessor and regulates all business modalities. Several agreement models are possible. The most important parts of the agreements are the amount of the lease rate, the term of the agreement, as well as payment modalities.
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The term leasing was created in the USA for a special form of grant of use. The word is derived from the Latin word “laxare” (to loosen) and the old French word “lais” and “laisser” (to allow). The English term “leasing” means to leave something to someone, to rent. In Germany leasing means the grant of use of an investment good for a certain period for money within the framework of a special agreement. It is referred to as a special agreement, because the lease agreement has essential characteristics of a lease agreement according to German Civil Code (BGB), however, it is not considered a lease agreement according to German Civil Code (BGB) due to certain details. Legally, a lease agreement, which also describes “product leasing,” is a contract with its own legal form, for which there is no foundation in German law. Certain standards have been defined regarding the fiscal aspect of lease agreements. A typical characteristic of the “product” leasing is that it almost always involves three parties. The customer = lessee, the supplier = manufacturer/salesperson, and the lessor.
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Leasing decrees are the guidelines created by the Bundesfinanzministeriums für Finanzen (German Finance Ministry) for the fiscal handling of lease agreements for movable goods as of April 19, 1971 for fully amortized agreements, and as of December 22, 1975 for partially amortized agreements. They are the foundation for the leasing business of movable goods in Germany. The decrees stipulate who is the economic owner of the object at which point in time of the agreement.The German Finance Ministry has published the real estate leasing decrees of 1972 (fully amortized agreements) and of 1991 (partially amortized agreements) for real estate leasing transactions.The leasing decrees by the German Finance Ministry are the decisive for the fiscal evaluation as well as the evaluation according to German Commercial Law of lease agreements. They regulate the accounting of economic property; i.e., the question of the lessee or the lessor having to account for the property. The leasing decrees stipulate that the basic term of lease agreements for movable goods may not exceed 40% of the expected useful life and may not fall below 90% of the expected useful life (fiscal depreciation time). For real estate lease agreements the term limit is 90% of the depreciation time. For a real estate leasing object, whose building application was filed after march 31, 1985 an expected useful life of 25 years is assumed. Therefore, the maximum term is 22.5 years. For older objects the assessed time must be adhered to.
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Once, at the inception of the agreement, the lessee receives a leasing invoice valid for the whole term of the agreement, containing all payment obligations, including VAT. The leasing invoice is proof for the deduction before taxes (§ 14 Umsatzsteuergesetz – German Excise Tax Code).
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Leasing object is the economic good invested with a lease agreement. All objects, which can be used as independent economic goods and which are fungible, are leasable.
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The leasing quota describes the share of leasing investments of the total equipment or real estate investments.
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Leasing of movable goods are leasing investments for movable investment goods, which are also called equipment investments. This includes operational appliances and immaterial assets (such as software).
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The leasing rate is the payment the lessee must make on a monthly or a quarterly basis for the usage of an economic good. Together with the rate and possible residual values or special payments the largest share of the lessor’s investment costs are amortized. The basis for the calculation of leasing rates is the purchase price, the term of the agreement, and the conditions on the capital market. The credit rating and the maintenance of value of the object influence the calculation as well. Leasing payments are – in a fiscal sense – operational expenses, which immediately influence the profit-and-loss statement.
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The lessee can be an individual or a legal entity. Within the framework of the lease agreement the lessor (leasing company) grants to the lessee the use of an object for money for a certain amount of time.
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The lessor is the leasing company. Most leasing companies are subsidiaries or partner companies of banks. Furthermore, bank independent corporations and manufacturer leasing companies operate on the market.
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Linear Payment Progression
Consistent lease rate for the whole term of the agreement.
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Machine Insurance (Technical Insurance) Machine insurance covers damage to movable and stationary equipment, such as construction, construction material, printing, plastics, and tool machinery. It also covers the following property damage: Fire, lightning, storm and hail, frost and ice, operational mistakes, unskillfulness, negligence, water, oil and grease defects, failure of measuring, control, and safety devices, rupture due to centrifugal force, excess pressure or low pressure, short-circuit, over current or over voltage with or without fire in electric installations, theft, burglary and robbery, vandalism. The insurance coverage protects the lessee and the lessor from considerable asset risks. Such insurance coverage is often part of a lease agreement.
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Manufacturers of investment goods use their own leasing offers to sell their products. For that purpose, they keep leasing companies as subsidiaries, which concentrate their sales activities on the manufacturer’s products. In exceptional cases they also conclude contracts for objects not produced by the manufacturer.
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Manufacturer Independent Leasing A free, manufacturer-independent leasing company serves its customers independent of the object and the manufacturer. It concludes all lease agreements for all investment goods selected by the customer, as long as they can be leased.
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Merchandising with Leasing Merchandising is sales support for the manufacturer and salesperson of equipment. That means that the product offering will be extended by a leasing offer. The investor receives all services pertaining to the investment from one source.There are many different forms of cooperation for the development of individual merchandising concepts for salespersons or manufacturers.
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The lessee’s obligation to return the object at the end of the lease to the lessor, if no other arrangements were made.
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Operating leasing (also called Operate Leasing) is an instrument with which the user (tenant/lessee) acquires a short-term usage right to an object, terminable at any time. The lease agreement can be compared to a rental agreement according to German Civil Code. In contrast to middle- and long-term financing the short-term usage of the investment good is the focus of an operating lease agreement. Its purpose is to bypass bottlenecks in production or sales. In connection with international accounting regulations (IAS/IFRS and US-GAAP), an operating lease agreement is given a new, additional meaning. An important characteristic of operating lease agreements is that the lessor’s financing costs are usually not amortized during the term of the agreement. The complete amortization is achieved when the object is leased several times and finally sold. These leasing objects have a high degree of fungability.
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At the conclusion of the agreement the lessee acquires the right to extend the agreement term or to purchase the object at the end of the lease term. The option price depends on the residual market value or the lowest fair value.
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In most planned leasing investments the customer (future lessee) will order the economic good from the supplier. After conclusion of a lease agreement the lessor enters the customer’s order. After the supplier’s invoice is paid by the lessor, ownership of the economic good is transferred from the supplier to the lessor.
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Ownership in case of Movable Goods Leasing In connection with leasing investment, the two following terms pertaining to ownership are especially important.
| – | Ownership according to civil law (legal ownership). The lessor becomes the owner of the economic good according to civil law after payment of the supplier’s invoice. German Civil Law – BGB § 433.
| | | – | Economic Ownership: The economic owner is the owner who exercises absolute rights over an investment good for the total useful economic life. This can be a different owner than the owner according to civil law. The economic owner is responsible for the accounting. German Tax Code - Abgabenordnung § 39.
The lessor is the owner of an investment good according to civil law and economically, if the non-terminable basic leasing term does not exceed 90% of the depreciation of fixed assets term and does not fall short of 40% of the depreciation of fixed assets term. Details regarding accounting are regulated in the “Mobilien-Leasing-Erlass“ (Decree pertaining movable goods) by the German Minister of Finance (Bundesfinanzminister). | |
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Partial Amortization Agreement (Movable Goods Leasing) The partial amortization agreement is a lease agreement model in which lease payments are only made on part of the purchase price. From a calculatory standpoint, a residual value remains on which the lessee does not make any payments during the term of the lease. The advantage of this agreement model is that lease payments are lower than they would be, if a fully amortized agreement had been concluded. A disadvantage can be that investment costs in the amount of the residual value can be deferred into an uncertain future.
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The purchase price when the exercise of a purchase option is agreed upon.
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For fully amortized agreements, a purchase option can be arranged. This option allows the lessee to purchase the leasing object after the termination of the lease agreement. The purchase price is the residual book value or the smaller fair market value (actual cash value). The actual cash value can only be determined when the leasing object is actually up for sale.
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The leasing company needs to have undisputed and unencumbered ownership according to civil law of the leased economic good. If the leasing company acquires objects from the future lessee in sale-and-leasing-back contracts, those objects are no longer unencumbered in most cases. Objects in a rented space are encumbered with a lessor lien; objects in someone’s own space are usually encumbered with a property lien, as long as there is a mortgage or a land charge on the real estate. In order to gain undisputed and unencumbered ownership the leasing company either needs a release of the lessor lien on the space or a release of the mortgage or land charge from the bank (or another land charge creditor).
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The purchase price of an investment good is written-off annually by a certain amount, i.e., reduced. Until the good is fully written off at the end of the economic life, the object has an annual book value, which is called residual book value. The residual book value can play an important role for the creation of lease agreements.
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The residual value in lease agreements is a calculatory factor to determine the lease payments. It is the amount for which the lessee does not pay during the term of the agreement. Lease agreements with a residual value are called agreements with partial amortization. The higher the residual value the lower the lease payments. In the lessee’s interest the residual value should depend on the residual book value and on the expected market value at the end of the lease term. The lessee is liable for the residual value towards the leasing company. Based on the residual value a subsequent lease agreement can be made. The market value determined at the end of the lease term is the basis for the sale of the leasing object to a Third Party or a lessee.
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The Right to Purchase is a purchase option. The Right to Purchase is an option the lessee has to secure his ownership of the leasing object. This right may be exercised, but does not need to be exercised.
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Sales Financing is when a manufacturer or salesperson offers a suitable means of lease financing for his investment products simultaneously with the product. For this purpose various cooperation agreements exist: It is possible that the future user acts as the lessee of the leasing object, or that manufacturer or salesperson himself acts as the lessee and leases the leasing object to his customers.
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Financing of an investment with one’s own assets.
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Lease agreements are often supplemented with services pertaining to the investment. This creates added value for the customer. The service offering ranges from object-specific insurance policies to vehicle fleet management of large vehicle fleets.
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The Parties of a lease agreement may agree upon a one-time payment when the agreement is concluded. This special lease payment is an advance payment and reduces the subsequent lease rates. Special payments are arranged when the object’s value maintenance is not secure, or in order to avoid other risks. Special lease payments are accounted for as deferred expenses and accrued income on the lessee side. The write-off is linear over the term of the lease agreement. In the lessor’s annual statement it is accounted for on the liabilities side of the statement.
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In individual cases, lease agreements include the right for sublease by the lessee. Example: A salesperson concludes lease agreements pertaining to devices, which he only wants to rent to the customer for short-term usage.
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Subsequent Lease Agreement A subsequent lease agreement is concluded at the end of the term of a lease agreement, when the lessee wants to continue using and leasing the economic goods. The leasing payments are much lower than the payments in the original agreement.
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The term of a lease agreement depends on the expected economic life of the leasing object (depreciation time), the usage intensity, the usage necessity, and, with regards to the accounting on the marginal rates from the leasing decrees. In general, the term of a lease agreement can be divided into two parts: The interminable basic term of between 40% and 90% of the depreciation time (if the lessor is responsible for the accounting) and the additional term, agreed upon with the lessee, which is independent of the usage. Another possibility is to differentiate between the individual contract types.
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Congruency of the imputed term of a lease agreement with the financing duration of the investment costs (acquisition value) agreed upon between the financing banks and the lessor. Term congruency assures that the leasing payments do not change during the term of the agreement, even if the interest rates on the capital market increase. Solidly financing leasing companies create the term congruency for their lease agreements.
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In the case of real estate investments the total investment costs comprise all capitalizable expenditures for the purchase and/pr production of the object. This includes the purchase costs of a lot of land as well as the construction costs of the building. The total investment costs also comprise all additional costs. Operating equipment with regards to the tax code is not part of the total investment costs on a real estate lease agreement. For operating equipment, lease agreements for movable goods may be concluded.
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The trade register is a publicly accessible register of merchants. It informs about fiduciary relations and powers of representation. In connection with engagement processing, current trade register excerpts of the lessee are very important.
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With the acceptance certificate the lessee confirms the receipt of a faultless and usable object. He must adhere to the manufacturer’s maintenance recommendations and then maintain the usability of the object for the term of the agreement. This includes the return of a usable object at the end of the term.
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US-GAAP (United States Generally Accepted Accounting Principles) are the US-American accounting regulations, according to which all public companies and US companies, including their European subsidiaries, must perform their accounting, if they are to be traded on the New York Stock Exchange. US-GAAP contains checking criteria for the accounting of lease agreements. US-GAAP differentiates between operating leasing agreements with accounting on the lessor’s side and capital lease agreements with accounting on the lessee’s side. The checking criteria contains marginal rates, such as agreement terms, cash values, and purchase options. It is recommended that a comprehensive consultation with the lessee’s accountant takes place before the conclusion of a lease agreement.
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Acquisition Costs and Acquisition Value
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