Definitions of Terms


Definitions of Terms

Bargain purchase option (BPO)

A provision in the lease agreement allowing the lessee the option of purchasing the leased property for an amount that is sufficiently lower than the fair value of the property at the date the option becomes exercisable. Exercise of the option must appear reasonably assured at the inception of the lease.

Contingent rentals

Those lease rentals that are not fixed in amount but are based on a factor other than simply the passage of time; for example, based on percentage of sales, price indices, market rates of interest, or use of the leased asset.

Economic life of leased property

IAS 17 (revised) defines economic life of a leased asset as either the period over which the asset is expected to be economically usable by one or more users or the number of production or similar units expected to be obtained from the leased asset by one or more users. (This was the definition of useful life under the original IAS 17.)

Executory costs

Those costs such as insurance, maintenance, and taxes incurred for leased property, whether paid by the lessor or lessee. If paid by the lessee, the lessee's obligation to pay such costs are excluded from the minimum lease payments.

Fair value of leased property (FMV)

The amount for which an asset could be exchanged between a knowledgeable, willing buyer and a knowledgeable, willing seller in an arm's-length transaction. When the lessor is a manufacturer or dealer, the fair value of the property at the inception of the lease will ordinarily be its normal selling price net of volume or trade discounts. When the lessor is not a manufacturer or dealer, the fair value of the property at the inception of the lease will ordinarily be its cost to the lessor unless a significant amount of time has lapsed between the acquisition of the property by the lessor and the inception of the lease, in which case fair value should be determined in light of market conditions prevailing at the inception of the lease. Thus, fair value may be greater or less than the cost or carrying amount of the property.

Finance lease

A lease that transfers substantially all the risks and rewards associated with the ownership of an asset. The risks related to ownership of an asset include the possibilities of losses from idle capacity or technological obsolescence and of variations in return due to changing economic conditions; rewards incidental to ownership of an asset include expectation of profitable operations over the asset's economic life and expectation of gain from appreciation in value or the ultimate realization of the residual value. Title may or may not eventually be transferred to the lessee.

Gross investment in the lease

The sum total of (1) the minimum lease payments under a finance lease (from the standpoint of the lessor), plus (2) any unguaranteed residual value accruing to the lessor.

Inception of the lease

The date of the written lease agreement or, if earlier, the date of a commitment by the parties to the principal provisions of the lease.

Initial direct costs

Initial direct costs, such as commissions and legal fees, incurred by lessors in negotiating and arranging a lease. These generally include (1) costs to originate a lease incurred in transactions with independent third parties that (a) result directly from and are essential to acquire that lease and (b) would not have been incurred had that leasing transaction not occurred; and (2) certain costs directly related to specified activities performed by the lessor for that lease, such as evaluating the prospective lessee's financial condition; evaluating and recording guarantees, collateral, and other security arrangements; negotiating lease terms; preparing and processing lease documents; and closing the transaction.

Lease

An agreement whereby a lessor conveys to the lessee, in return for payment or series of payments, the right to use an asset (property, plant, equipment, or land) for an agreed-upon period of time. Other arrangements essentially similar to leases, such as hire-purchase contracts, bare-boat charters, and so on, are considered leases for purposes of the standard.

Lease term

The initial noncancelable period for which the lessee has contracted to lease the asset together with any further periods for which the lessee has the option to extend the lease of the asset, with or without further payment, which option it is reasonably certain (at the inception of the lease) that the lessee will exercise.

Lessee's incremental borrowing rate

The interest rate that the lessee would have to pay on a similar lease, or, if that is not determinable, the rate that at the inception of the lease the lessee would have incurred to borrow over a similar term (i.e., a loan term equal to the lease term), and with a similar security, the funds necessary to purchase the leased asset.

Minimum lease payments (MLP)
  1. From the standpoint of the lessee. The payments over the lease term that the lessee is or can be required to make in connection with the leased property. The lessee's obligation to pay executory costs (e.g., insurance, maintenance, or taxes) and contingent rents are excluded from minimum lease payments. If the lease contains a bargain purchase option, the minimum rental payments over the lease term plus the payment called for in the bargain purchase option are included in minimum lease payments.

    If no such provision regarding a bargain purchase option is included in the lease contract, the minimum lease payments include the following:

    1. The minimum rental payments called for by the lease over the lease contract over the term of the lease (excluding any executory costs), plus

    2. Any guarantee of residual value, at the expiration of the lease term, to be paid by the lessee or a party related to the lessee.

  2. From the standpoint of the lessor. The payments described above plus any guarantee of the residual value of the leased asset by a third party unrelated to either the lessee or lessor (provided that the third party is financially capable of discharging the guaranteed obligation).

Net cash investment in the lease

A term that was used by the original standard IAS 17 as a basis upon which to compute the return to the lessor; this method was eliminated when IAS 17 was revised.

Net investment in the lease

The difference between the lessor's gross investment in the lease and the unearned finance income.

Noncancelable lease

A lease that is cancelable only

  1. On occurrence of some remote contingency

  2. With the concurrence (permission) of the lessor

  3. If the lessee enters into a new lease for the same or an equivalent asset with the same lessor

  4. On payment by the lessee of an additional amount such that at inception, continuation of the lease appears reasonably assured

Nonrecourse (debt) financing

Lending or borrowing activities in which the creditor does not have general recourse to the debtor but rather has recourse only to the property used for collateral in the transaction or other specific property.

Operating lease

A lease that does not meet the criteria prescribed for a finance lease.

Penalty

Any requirement that is imposed or can be imposed on the lessee by the lease agreement or by factors outside the lease agreement to pay cash, incur or assume a liability, perform services, surrender or transfer an asset or rights to an asset, or otherwise forego an economic benefit or suffer an economic detriment.

Rate implicit in the lease

The discount rate that at the inception of the lease, when applied to the minimum lease payments, and the unguaranteed residual value accruing to the benefit of the lessor, causes the aggregate present value to be equal to the fair value of the leased property to the lessor, net of any grants and tax credits receivable by the lessor.

Related parties in leasing transactions

Entities that are in a relationship where one party has the ability to control the other party or exercise significant influence over the operating and financial policies of the related party. Examples include the following:

  1. A parent company and its subsidiaries

  2. An owner company and its joint ventures and partnerships

  3. An investor and its investees

Significant influence may be exercised in several ways, usually by representation on the board of directors but also by participation in the policy-making process, material intercompany transactions, interchange of managerial personnel, or dependence on technical information. The ability to exercise significant influence must be present before the parties can be considered related.

Renewal or extension of a lease

The continuation of a lease agreement beyond the original lease term, including a new lease where the lessee continues to use the same property.

Residual value of leased property

The fair value, estimated at the inception of the lease, that the enterprise expects to obtain from the leased property at the end of the lease term.

Sale and leaseback accounting

A method of accounting for a sale-leaseback transaction in which the seller-lessee records the sale, removes all property and related liabilities from its balance sheet, recognizes gain or loss from the sale, and classifies the leaseback in accordance with this section.

Unearned finance income

The excess of the lessor's gross investment in the lease over its present value.

Unguaranteed residual value

Part of the residual value of the leased asset (estimated at the inception of the lease) the realization of which by the lessor is not assured or is guaranteed by a party related to the lessor.

Useful life

The estimated remaining period over which the economic benefits embodied by the asset are expected to be consumed, without being limited to the lease term. (The former definition of this term, as employed in the original standard IAS 17, has now been assigned to the term economic life.)