When should lessor register as foreign corp?
Within a state …
Good – stock of them
Services offered
Inspection or repair of property
Office/employees
Negotiated contracts
What is dode of Hammurabi?
- 1750 BC
- Acknowledges leasing of personal property in his code of laws
- First record of leasing law
Early examples of true lease?
- Phoenicians shipping experts
- charters covered economic life of ships
- lessee to assume benefits and obligations of ownership
What is Statue of Whales?
- 1284 AD
- leasing personal property
- 1571 defined who owned the lease property
What is Philadelphia Plan?
- 1700’s railroads companies only afford tracks
- Finance from private investors for locomotives/cars
- equipment trusts
- precursor of today conditional sale contract
When & how did Independent Leasing Start?
- 1900’s
- Offer short term contracts/leases
- lessor retain title
- rail cars would be returned at end
- beginning of true/operating lease
- third party leasing companies
What is definition of captive?
- sub of mfg. primary purpose to finance parents product
What is the benefit of captive?
- Sales aid
- market control
- product differentiation
- Increase gross margin
- Ongoing customer contact
Why did lease re surge in 1950’s?
- government stimulate economy after WWII
- advance in technology in business equipment
- IRS 167
How does IRS 55-540 define true lease?
P – payment exceed FMV – NOT
A – automatic titletransfer – NOT
I – interest contained in payment – NOT
N – nominal purchase option – NOT
E – equity in lease – NOT
E – excessive lease payments – NOT
What is different between FASB 13 and IRS 55-540?
-FAB 13 – defines operating lease – ACCT
- IRS 55-540 – defines tax lease – TAX
What is FASB 13?
- 1976 Financial Accounting Standard Board
- Issued statement 13
- Set criteria by which to classify a lease capital/operating
- defined treatment on financial statements
How does FASB 13 define an operating lease?
B – bargin purchse option – NOT
E – economic useful life > 75% – NOT
A – automatic title transfer – NOT
P – PV of payments (no resid) > 90% of FMV – NOT
What is AMT?
- Alternative Minimum Tax
- pay greater of regular tax or AMT
- limits depreciation benefit
- prompted growth in operating lease (lessee)
What is definition of Lease
- a transaction in which use and possession but not title to tangible property, is transferred for consideration
- USE AN POSSESSION
- NOT TITLE
- TRANSFERRED FOR CONSIDERATION
What are the key “from whose eyes” comparisons?
- lessee vs. lessor
- operating vs capital (accounting)
- tax vs. non-tax (tax)
- true lease vs. secured transaction
What is ASC 840?
- Accounting Standard Codification 840
- updated FASB 13
Key Elements of Lease Transaction?
- lessee must sign
- lessor must sign
- paid invoice is transfer of ownership
- paid invoice is not transfer of title
What is a Finance Agreement?
- EFA
- Installment Sale
- titleholder and user are the same
What is a single investor lease?
- tow parties
- lessor
- lessee
What is third party lease?
- three parties
- lessor
- lessee
- dealer/vendor
What is Section 38?
- IRS Section 38
- defines personal property that can be leased as depreciable property
What is IRS 179?
- tax deduction loaded to the front of the lease
What is Leveraged Lease?
- non recourse
- three parties – lender, funding source. lessee
- lendor assigns rights to funding source
- tax oriented benefit to lender
- lender responsible for maintenance, insurance & tax
- net investment declines and rises over time
What is Discounting?
- originate, document -> discount
- lessor receives payment immediately PV of stream
- lessor remains lessor of records and ultimately responsible
What is Operating Lease?
- fails FASB 13
- lessee doesn’t own asset
What is Capital Lease?
- triggers FASB 13
- aka Finance Agreement
- P.O. – $1.00, $101, 10%
What is Full Payout Lease?
- realize investments over stream of payments
- no reliance on residual to recoup investment
What is a Finance Lease?
- net lease (cost paid by lessee)
- lease over major portion of property useful life
- often incorrectly confused with non tax lease
What is Net Lease?
- lease with all cost in connection to the use are paid separately by lessee
- insurance, maintenance, tax
- non included in rental payment
What is Master Lease?
- form of documentation
- outlines basic terms and conditions
- separate schedule referring to main document
What is Money Over Money?
- non tax lease
- conditional sale
- guise of a lease
- title intended to pass at end of term
What is Closed End Lease?
- lease with no purchase option
- must be returned
What is Upfront Monies?
- Security Deposit
- Advanced Rentals
- Fees
- Can raise yield
What are Soft Costs?
- cost associated with equipment
- can be included in lease
- installation, warranty etc.
What is At-Risk?
- IRS code
- party seeking tax benefit must retain risk
- need skin in the game
What is Stipulated Loss?
- remaining payments discounted at a rate
What is Fair Market Value?
- price willing seller & buyer negotiate in open marketplace
What is placed in service?
- in use for intended purpose
What is Security Deposit?
cash deposit for performance
What is Stream Rate?
- implicit rate of steam
- does not give lessee total picture
What is Interim Rent?
charge of use of equipment form delivery to start date
What is Residual Value?
expected value of leased equipment at end of lease
What is Rental Agreement?
short term lease, typically 12 mos or less
What is purpose of lessor/vendor relationship?
- increase sales
- earn commission
- easier to market equipment
- more favorable terms
What are some documentation barriers in building vendor relationships?
- right of first refusal
- Hold back
- Re marketing agreement
- Recourse agreement
- Private Label
What should be included on vendor invoice?
- sold to leasing company
- shipped to lessee
- full equipment description – serial numbers also
What is UCC Article 2A?
- distinguishes supplier and funder
- guard against “agency”
- ensure’s arms length transaction
- helps “hell or high water”
Name five forms of Vendor Fraud?
- bunk lessee
- bunk equipment
- false sale leaseback
- bunk signature
- side agreements
- inflated prices
- used vs. new
What is UNL?
- ultimate net lose
- recourse arrangement
- funds in pool are used to cover ultimate loss after resale and legal
List Accounting Lease Classification
Operating, Capital Loan
List Tax Lease Classification?
Tax Lease (True Lease), Non Tax Lease (Non True Lease) (aka conditional sale)
List Legal Lease Classification?
Lease, secured financing, unsecured financing
What is Residual/Unguaranteed Residual?
the estimated fair value of lease property at end of term
What is Bargain Purchase Option?
lessee purchasing lease for less than fair value
What is difference in Financial Statements & Tax Returns?
- financials are accrual basis
- financials are straight line depreciation
- taxes are cash basis
- taxes are accelerated depreciation
What is the Year 1 MACR % for 5 years?
20%
What is Current Ratio?
-CURRENT ASSETS / CURRENT LIABILITIES
- higher is better
What are the different financial statement preparation levels?
- compilation – assemble with no inquiry
- reviewed – inquiry/analysis
- audit – verify with third party
What is Full Disclosure financial statements?
footnotes highlighting key items
footnotes explaining deviation from GAAP
What is Statutory Law?
- law enacted by legislative bodies
- includes UCC
What is Case Law?
- cases that apply to statutory or prior cases
What is Regulatory Law?
- regulations adopted by public bodies
- IRS & SEC are examples
What is Conflicts of Law?
inconsistencies in stat law
What is Statute of Fraud
- must have contract in writing
- if not, may not be enforcable
- total payments > $1,000
What is Legal Definition of Lease?
- not definition but rather what is it NOT
- many “weight of the evidence” type decisions
- all encompassing
- unlike accounting or tax definition, way more than 5-6 tests – more common sense.
What is UCC Article 2 ?
- law of sale of goods
- Lessor may be deemed vendor
- implied warranties
What are UCC Article 2 Implied Warranties?
- merchant sells goods deems to warrant they are fit for ordinary purposes, good condition
-May be excluded with “conspicuous disclaimer such “as is”
What is UCC Article 9?
- law of secured transactions
- record real property used UCC1
- perfect interest in collateral
Where do you file UCC 9?
in state where lessee is incorporated
Who has priority with UCC 9?
generally, first to file
Are UCC 9 required for Leases?
- No but good idea
- In the event transaction not found to be lease, secured creditor has rights to equipment in BK
In BK, lease or secured lender more likely to get equipment back?
Lease
To gain PMSI, how long do you have to file UCC?
20 days
What else is required to earn PMSI?
- lessor must pay for substantially all the equipment
- significant vendor DP, may jeopardize PMSI
To test a scenario in which a PMSI or Blanket Lien prevails, what needs to be analyzed?
- is secured transaction?
- UCC filed in 20 days?
- did lessor pay for majority of equipment?
What is Article 2A?
- Law of True Leases
- Includes implied warranties
- warranties wived with conspicuous language
Where is UCC filed?
SOS in state where company is incorporated
What are UCC Article 2A Benefits to Lesssor?
- warranties are passed to lessee
- lessor absolved from equipment issues
- hell or high water clause should be in lease
How long is UCC good for?
5 years
What are Express Warranties?
any warranty specifically made by lessor
What are Implied Warranties?
- quiet possession
- vendor warranties pass to lessee (goods are fit for use etc.)
Define ‘doing business in’ another state
- Visit often
- Agent present presence of agent
- Tax paid
- Office
When should lessor ‘register” as foreign corporation?
Within a state…
-Goods
-Offices
-Inspection/repair
-Contract negotiation
-Services
What is Acceptance in a lease document?
Lessee accepts equipment when delivered
What is Assignment of a Lease in a document?
- probitslessee from assigning (sub -lease)
- allows lessor to assign without notice to lessee
What is Disclaimer of Warranties in a document?
- LESSOR ASSIGNS ALL WARRANTIES TO LESSEE
Lessor make not warranties of quality of equipment - lessee has inspected and is satisfied
- lessee accepts “as is”
- equipment is for business purposes
What is Severability in a document?
- if one part of the doc is not enforced, other parts are still legally binding
What is Choice of Law?
- state that governs the transaction
- should be lessee, lessor or equipment state
- courts typically uphold if reasonable
What is Acceleration in a document?
In default, lessor claims all future rental are now due
What is Cross Default in a document?
if lessor has multiple leases, a default of one defaults all
What is Hell or Highwater in a document?
- lessee must make payment regardless
- equipment failure or catastrophes do not exempt from payment
What is Waiver of Defense Clause in document?
- lessee pays payments to assignee
- any legal issues fall to the original lessor, not assignee (i.e. discount scenario)
What is Tax Indemnity in documents?
states that lessee is responsible for all taxes of any kind imposed on possession, use, value or payment
What is best way to certify signors?
Corporate Resolution document
Who signs a Landlord Waiver?
Owner and Lessor
What if you forget to file a Landlord Waiver and you need to access your equipment in default?
Do your best to negotiate directly with the owner. They may understand and cooperate.
When is a Real Estate Waiver required?
When equipment is secured/fastened/attached to real property or building.
Where is Fixture Filling Recorded?
- local county recorder of real property
- file as soon as possible < 20 days
What are the most important Acts of Default?
- failure to pay
- failure to pay other sums due (i.e. insurance)
- failure to perform act or obligation under lease
What is CFLL?
- CA Lenders License
- any person makes loans – personal or commercial
What is UCC Article 10?
CA version of UCC Article 2A
What are some common methods of lessor financing?
- self funded
- broker
- discounting
- debt/equity
- securitization
What are advantages of Brokering?
- requires little/no capital
- easiest
- no servicing required
What are disadvantages of brokering?
- limited profit
- lacks control
- loss long term relationship to funding source
Who owns equipment in a Discounting scenario?
Lessor
What are advantages of Discounting?
- lower COF
- flexibility
- brand identity
- increased revenue
- retains customer
What are disadvantages of Discounting?
-significant reps and warranties
- retains some risk (i.e. residual)
- requires working capital
- potentially less upfront profit.
What are advantages of Equity/Debt funding?
- retain long term economic benefit
- control – underwriting, funding etc
What are disadvantages of Equity/Debt funding?
- risk
- limited capital
- large back-office requirements
What is Asset Securitization?
Aggregation of similar types of assets (leases) into a legal structure
- Assets used as collateral to issue bond/note
What are advantages of Securitization?
- low cost of funds
- potential off balance sheet (bk remote company)
- access to capital markets
What are disadvantages of Securitization?
- requires expertise
- huge cost to conduct
- time consuming
- need uniformity in assets
- complexity in accounting
How are Partnership Tax Liabilities treated?
income or losses of partnership are divided among owners.
Lessor can only pursue principal with respect to which types of entities?
- sole proprietor
- general partner
What is the only entity not taxed on a personal basis?
C Corp
How many owners are required in a LLC?
one (1)
What is the purpose of Credit Scoring?
- consistent decisions
- efficient process
- monitor costs
What are ways to enhance credit?
- SD
- Adv. Pymts
- Shorten term
- Add’l pg
- vendor guaranty
- add’l collateral
- fees
- vendor discounts
- co-lessee
With which type of financial statements does it make sense to also require tax returns?
compiled and reviewed
What is unique about Reviewed statements?
- confirm authenticity
- inquire internally
- analysis is performed
What is unique about Audited statements?
- highest level
- opinion of fairness
- conducted in accordance GAAS
- performed by independent licensed CPA
What is Debt to Equity
DEBT / EQUITY
- measures leverage compared to equity
- higher is more risk of failed repayment
- higher has more cash flow risk
- average 7:1 for lessors
What is Current Ratio?
CURRENT ASSETS / CURRENT LIABILITIES
- measure of liquidity or ability to repay short term debt
- higher is better
- ideally over 1.25
What is Quick Ratio?
[CASH + A/R] / [CURRENT LIABILITIES]
- another measurement of liquidity
- only considers assets “close to cash”
- aka Acid Test
- ideally > 1:1
What is Return on Equity (ROE)?
NET INCOME / EQUITY
- measure of profitability
- steady or growing with industry average
- should be reviewed in context of debt
- not firm good – but 25%+ is good
What is Profit on Sale?
GROSS PROFIT / TOTAL SALES
- measure of profit margin
What are the unique characteristics of each org type?
What is the key primary responsibility of the collection department?
- Maintain goodwill with client
- Collect leases
- Recognize signals
- Know collection practices
- track portfolio
- keep losses down
What are secondary collector responsibilities?
- legal
- repo
- remarket
- bK
What is Chapter 7?
-Liquidation BK – personal
What is Chapter 11?
- Reorganization BK – Business
- also reorg for individuals with > $150K networth
What is Chapter 12?
- Reorganization BK Ag/Farmers
What is Chapter 13?
- Reorganization BK Inidividuals
What is Relief of Stay?
- filed by Lessor to request removal of Automatic Stay
- filed by Bar Date
What is Proof of Claim?
- amount and nature of debt being claimed
- does not require attorney to submit
- filed by bar date
What is Assume or Reject?
- Chapter 11 & 13
- debtor may assume or reject TRUE LEASE
What is Summons & Complaint?
A summons is a written notice, which usually is accompanied by the complaint, notifying the defendant and the court that the complaint has been served on all relevant parties and listing the date of the first court appearance for the lawsuit.
What is important to know about payments received around the time you receive bankruptcy notice?
if within 90 days, may need to be returned to bk court
With whom an collections matters be discussed?
- PG
- employees in building
- lease applicant
- CFO/COO/Officers
What is Commercially Resonable Sale?
- written notice to lesse/guarantors
- public auction
- notice of auction date, time & Location
- published in local paper – 5 days prior
What if not Commercially Reasonable Sale?
lessor forfeits rights to pursue lessee for deficiencies
What personal assets cannot be garnished?
401k, IRA, Retirement Accounts
What is Marketing?
The process of finding, DEVELOPING and profiting from opportunities
What are key elements of Marketing Plan?
- Exec Summary
- Situation Analysis
- Marketing Strategy
- Financials
- Controls
Where does Mission Statement belong?
Executive Summary
What are the key elements of Situational Analysis?
- market summary
- environmental audit
- funding
- keys to success
- critical issues
- historical results
What are some ways to research a market
- trade journals
- associations
- internet
- D&B
- Chamber of Commerce
- ELFA
What are some forms of influencers that could introduce prospects?
- attorneys
- vendors
- CPA
- banks
- other leasing companies
- Associations
What is another name for Market Summary?
Go To Market Strategy
How can SWOT help marketing plan
- help you take advantage of what you do well
- avoid what you do not do well
- focus on biggest opportunities
- avoid risk
What are four (4) P’s of marketing?
- Product – RESEARCH FUNDING SOURCES
- Place – direct or indirect sales
- Price – based on many factors
- Promotion – how you advertise
What would be an examples of Promotion?
Application only, fast turn, industry knowledge, flexible, structure, wide credit window etc.
What are ways to measure success in Marketing Plan Financials?
- volume
- penetration
- market share
- ROI
- ROE
- ROA
What is key to marketing to banks?
- banks may not offer leasing
- clients may reach legal lending limit
- lease may be preferred to loan
- risk may not be acceptable to bank
- too large/small transaction
- add’l fee income
What are ways to build relationships with banks?
- meet establish confidence
- share marketing/sales plan
- offer to train and provide marketing material
What is Assumptive Close?
You assume they are taking your deal an proceed to close
What are CLFP’s thoughts on spiffs/rebates?
CLFP frowns upon them
What shoudl be avoid when submitting a deal to funding source?
Don’t shotgun deals to multi lenders at once.
What is difference in marketing vs sales?
- marketing efforts occurs prior to sales
- marketing supports sales
- sales acts on opportunities generated by marketing
What are the steps in selling process?
- lead development
- prospecting
- info gathering
- presentation
- overcome objections
- closing
How is the selling process conducting porcess conducted across many different companies?
- all companies handle differently
- some buy lists, some cold call, some vendor, some broker etc.
What is key with respect to interim rent in selling process?
Should be introduced early in the process?
What is Direct Selling?
- employees of your company
- focus on selling your product
- maintain control
What is Indirect Selling?
- selling through dealers or independent reps
- easier to scale up/down
- less control
What are characteristics of a strong sale person?
- on time
- organized
- take initiative
- empathetic
- understands sales cycle
- knowledgeable
- works well with others
- team player
What is the Primary sales tool for a saleman?
Knowledge – creates efficiency and opprotunity
What are some examples of how a salesperson could structure a deal to win?
- Client pays AMT – True lease
- Client need depreciation – capital lease
- Client violated covenant – operating lease
What is important to remember about Lease vs. Buy analysis?
doesn’t always result in lease being the “lowest cost” option
What are some Lease vs. Buy variables?
- Termination Option
- Cost of capital
- How will it be used
- tax rates (state, federal, sales, ppt)
- depreciation treatment
What is an important concept related to Key Management?
- Sales/Marketing
- Finance/Accounting
- Risk Mgmt.
- need to work well together
What is a key concepts with respect to budget?
- should be in sync with business strategy
- top management should be involved
- changed throughout year.
What is the budget creation process?
- submit by department
- reviewed by management
- request revisions
- repeat until complete
What are key budget elements?
- growth
- economy
- past history
- cost of capital
What is important about Cost of Capital with respect to budget?
- lower COF – more flexibility
- COF may determine LESSOR or BROKER model
What some major cost for Leasing companies?
- Cost of capital
- marketing
- reserves
- payroll
What are common reserve targets?
1.5 – 2 times annual losses
How is Outsourcing viewed in the leasing industry/
it is a good management practice.
What is Direct Finance Lease?
a lease in which the lessor does not select, manufacture, or supply the goods
Lease Intended As Security
Transaction which is written in the form of a lease, but the substance is a conditional sale contract or a loan with a security agreement on the property.
Sales-Type Lease
From the lessor’s perspective – a capital lease that gives rise to manufacturer’s or dealer’s profit to the lessor
What is Step Payment Lease?
Lease that contains a payment stream that requires the lessee to make payments that either increase (step-up) or decrease (step-down) in amount over the lease term.
What is TRAC lease?
A lease on a qualified automobile, truck or trailer, which may be considered a true lease for federal income tax purposes even though it contains a clause which effectively guarantees the lessor the residual value.
What is a Wet Lease?
A gross lease, traditionally for aircraft or marine vessels in which the lessor provides bundled services such as the payment of property taxes, insurance, maintenance costs, and provisions necessary to operate the craft (e.g., personnel, fuel, etc.)
What is a Progress Payment?
Payments required by an equipment vendor or manufacturer prior to delivery of equipment to be leased. The progress payments lessen the outlay necessary for the vendor to purchase the equipment or the manufacturer to build the equipment and it adds an economic penalty if an order is cancelled mid-stream.
What is Chattel?
Personal property
What is Cross Border Financing?
The providing of leasing or financing by a funder in one country for a lessee or borrower in another country. Such transactions are subject to each country’s applicable tariffs.
What is Bundled Lease?
A lease that includes many additional services such as maintenance, insurance and property taxes that are paid for or performed by the lessor; the cost is built into the lease payments. Also referred to as a “full-service lease.”
What is a Service Lease?
A lease in which the lessor provides service(s) such as maintenance and care of leased property. The cost of such service(s) may be built into the lease or it may be paid under a separate maintenance agreement that the lessee was required to purchase.
Equipment Lease
A transaction in which use and posession but not title to tangible property, is transfered for consideration.
Section 38 Property
IRS (tax) defines personal property that can be leased as depreciable property.
Third Party Leasing
Unrelated Maufacturer, Dealer or Broker, the independent lessor and the lessee.
Balance sheet
(Op Lease)
Includes
Assets
C ash
A sset
T otal assets
Liabilities
S ecurity deposit
E quity
T otal liabilities
Income statement
(Op Lease)
Includes
I ncome
R ental
E xpense
D epreciation
N et Income
Balance sheet
(Cap Lease)
Includes
Assets
C ash
M minimum lease pmts
U nearned residual
U nearned income
N et investment
T otal assets
Liabilities
S ecurity deposit
E quity
T otal liabilities
Income statement
(Cap Lease)
Lease income
Net income
Revenue Ruling 55-540
Lease Classification for tax (IRS) purposes
Ruling 55-540 Criteria – Not a Lease if:
Any portion of payment is applied tot he equity position
Ruling 55-540 Criteria – Not a Lease if:
Title transfers automatically
Ruling 55-540 Criteria – Not a Lease if:
Payments are an inordinately large portion of the OEC
Ruling 55-540 Criteria – Not a Lease if:
The rental payments greatly exceed the current FMV
Ruling 55-540 Criteria – Not a Lease if:
There is a nominal or bargain purchase option
Ruling 55-540 Criteria – Not a Lease if:
Some portion of the payment is designated as interest
FASB13
1976
Lease Classification for Accounting Purposes
FASB13 Criteria – Not an Operating Lease if:
Title transfers automatically
FASB13 Criteria – Not an Operating Lease if:
There is a nominal or bargain purchase option
FASB13 Criteria – Not an Operating Lease if:
Lease term is greater than 75% of economic life of property
FASB13 Criteria – Not an Operating Lease if:
The PV of the minimum payments is equal to or greater than 90% of the FMV
Who must sign a Lease?
Lessee and Lessor
Transfer of ownership happens when:
a vendor issues an invoice and it is paid in full
Finance Contract
The title holder and user of the equipment are the same
First record of leasing law
1750 BC – the Code of Hammurabi
Early Examples of a true lease
Phoenicians with shipping
Used to obtain a ship and crew
Statute of Whales
1284 AD
Used in England to deal directly with the leasing of personal property
Industrial Revolution
1700s – Railroad industry sought financing for the railcars because they could only afford the train tracks
Philadelphia Plan
1700s Industrial Revolution
The most well know finance plan of the time
Section 167
Issued by IRS in 1950s to stimulate the economy after WWII and for the advancement of technology
55-540 – Criteria
P – Payments cannot exceed the FMV
55-540 – Criteria
A – no Automatic title transfer
55-540 – Criteria
I – No portion of payment classified as interest
55-540 – Criteria
N – No nominal purchase option
55-540 – Criteria
E – payments cannot exceed the original purchase price
55-540 – Criteria
E – lessee cannot contribute tot he equity
Investment Tax Credit
1960s
credit a taxpayer could claim on tax return which is a direct offset to tax liability (new equipment)
Accelerated Depreciation
allows the owner of equipment to depreciate for tax purposes faster which results in faster tax benefits
Revenue Procedure 75-21
Used to determine what IS a tax lease
Revenue Procedure 75-21
initial minimum investment made by lessor
Revenue Procedure 75-21
lease term and renewal options defined in the lease
Revenue Procedure 75-21
defined purchase and sales rights must not be less than FMV
Revenue Procedure 75-21
no investment by lessee
Revenue Procedure 75-21
lessee cannot make a loan to lessor for the lease or guaranty the lessor’s loan used to pay for equipment
Revenue Procedure 75-21
lessor must be able to demonstrate they intend to make a profit from more than just tax benefits
ERTA
1981
Economic Recovery Tax Act
Created ACRS
ACRS
Accelerated Cost Recovery System
TRA 86
Tax Reform Act of 1986
Eliminated ITC
Strengthened AMT
ITC
Investment Tax Credit
AMT
Alternative Minimum Tax
Why is equipment leasing & finance popular
- Psychology of use over ownership
- Non restrictive bank covenants
- reduce burden of equipment obsolescence
- more affordable to lessee than to purchase
- tax advantages to both lessors and lessees
- diversification of financing sources
- conserve working capital (cash flow)
- off balance sheet financing (for now)
- experience of the leasing industry
- flexibility in structure
- convenience to the lessee
What applicant attributes are you trying to learn about when underwriting a deal?
1.) The desire to repay the debt
2.) the financial ability to make payments
3.) The reserves to withstand unexpected setbacks
What are the four (4) C’s of Credit?
1.) Character: the desire to pay back debt
2.) Cash Flow: Ability to make payments
3.) Capital: Ability to withstand setbacks
4.) Collateral: Ability to liquidate to recover investment when the initial three (3) C’s fail
What are common credit criteria in the app only process?
1.) TIB
2.) Industry
3.) Equipment type
4.) Bank Balances
5.) Personal Credit Reports
6.) Business Credit Reports
7.) Landlord rating
8.) Vendor quality
9.) Lease structure
10:) New/Used equipment
11.) Equipment location
12) Comp credit
13) SOS
14) References
Characteristics of App Only?
1.) limited upfront information (application)
2.) low-touch, high volume
3.) Credit scoring
What are common credit criteria of mid ticket credit process?
1.) TIB
2.) Principal’s credit
3.) deal structure
4.) equipment type
5.) 2-3 years financial analysis (statements)
6.) background check
7) trade & bank references
How does Entity type impact underwriting?
1) different credit risks/considerations
2)different legal risks/considerations;
3) different documentation requirements
Describe a Sole Proprietorship?
1.) An individual who owns a business
2.) No legal requirements apart from business license
3.) Typically DBA or “doing business as”
4.) Don’t file separate tax returns – 1040 Schedule C
5.) Tax Return: Income reported before owner draw/taxes
6.) Cash flow: income after tax and draw
Describe a Partnership?
1) Two or more people doing business documented with Partnership Agreement
2.) Separate financial & tax statement
3.) Income is generally reported prior to draw/tax
4.) Profits/Losses distributed to partner in accordance with agreeemnt
What is General Partnership?
Partnership with two or more people/entities each of which is legally liable for business.
What is Limited Partnership?
Partnership with two or more people/entities with at least one General Partner and the others Limited Partners. General Partners are liable for all company activities. Limited Partners liability is limited to their investment.
What is a Joint Venture?
1.) Two or more companies with common interest created for a specific project
2.) share financial statement
3.) Share profit/loss
4.) Dissolve at some date.
What is a Corporation?
1.) a separate legal entity in the view of other business, the law and by taxing authorities.
2.) investors buy share and own company
3.) Shareholder typically individuals
4.) Shareholders draw money via salaries/dividends
5.) Corporation files separate tax returns.
What is C Corp?
Basic corporaiton form. No limit to shareholders
What is S Corp?
1.) Sub S Corp
2.) Specific IRS guidelines taxed in the manner of a partnership
3.) Profits/losses flow to shareholders.
What is Non-Profit Corporation?
1.) typically formed to provide service i.e. hospital/charity etc.
2.) motives are not profit oriented;
3.) certain tax,pension and liability benefits
4.) to be liable, shareholder must sign personal guarantee
What is Limited Liability Company LLC?
1.) SImiliar to Sub S in which profits/losses flow to shareholders
2.) Owners can be individuals or shareholders (no limit)
3.) Manager typically appointed to run
4.) no personal liability for llc members
What is an Association?
1.) Used by organizations not in commercial enterprise
2.) Usually non-profit
3.) Few assets
4.) If leasing, must be approved in bylaws with instructions on who is authroized
What is a Trust?
1.) formed to hold an asset for benefit of others;
2.) Trust agreement should be reviewed prior to lending to determine relevant parties and who is authorized to sign
What are the characteristics of a Municipality?
1.) local or government entity (city, state etc.)
2.) Use “fund accounting”
3.) Issue their own budget and financials
4.) Income typically consists of taxes
5.) “fund balance” equivalent of equity in business
6.) Typically, cannot commit to leases more than a year
7.) Longer term leases have “fiscal funding class” or “non-appropriation” language allowing them to cancel.
What are the characteristics of a Federal Government lease?
1.) can borrow money based on congressional laws
2.) typically does not obligate long term
3.) May use long term bonds to fund
4.) different agencies use different methods
Describe a common financial analysis process
1.) Spread statements with common size assets, liabilities and expenses;
2.) projected balance sheet with impact of new detbt
3.) Income statement review with notes on key items
4.) Interim statement analysis – be aware of seasonality
5.) Cash flow calc
6.) Cash throw-off
7.) reconcillation of net worth
8). key ratio analysis
What should you look for when recon Net Worth?
[Total Net Worth Previous Year] + [Net Income This Year (after tax, div, dist)] = [Total Net Worth This Year]
What are key financial analysis considerations?
1.) earnings stability of company
2.) earnings stability of industry
3.) Kind of assets
4.) Liquidity
5.) Debt Maturities and related impact
6.) Purpose of debt
7.) Interest expense
8.) Contingent liabilities
9) Capital structure and solvency
10.) Cash flow coveage
What does the Risk Management Association (RMA) offer?
1.) industry average financial ratios
2.) compiled with data from commercial banks
3.) companies that do not need or qualify for bank financing are excluded
What is Gross Margin?
GROSS PROFIT / SALES
What is Net Profit Margin?
1.) NET PROFIT / SALES
2.) Ratio of profit after tax
3.) Important to take in consideration S Corp distributions
What is Return on Asset (ROA)?
1.) NET INCOME / TOTAL ASSETS
2.) Measure effectiveness of mgmt employing resources
What is Return on Equity?
1.) NET INCOME / NET WORTH
2.) Note increased ROE with increased leverage is not necessarily good
What is Current Ratio?
1.) TOTAL CURRENT ASSETS / TOTAL CURRENT LIABILITIES
2.) Measure of company to meet short term liabilities
3.) 1.25:1 is target
What is Quick Ratio:
1.) [CASH + RECEIVABLES + MARKETABLE SECURITIES] / CURRENT LIABILITIES
2.) Acid test
3.) 1:1 is target
4.) best measure in gauging ability to meet short team liabilities
What is Days Receivable?
1.) DAYS IN PERIOD / [NET SALES/AR]
2.) Avg time in days to collect receivables
3.) Lower is better
What is Sales/Receivables?
1.) NET SALES / AR
2.) Represents # of times Receivables turn in a year
- ) Bigger is better
What is Net Sales to Working Capital?
1.) NET SALES / WORKING CAPITAL
2.) Measures how efficiently working capital is deployed
3.) Low ratio means inefficiency
3.) Too high may be over trading
What is Days Inventory?
1.) DAYS IN PERIOD / [COGS/INVENTORY]
2.) Time required to convert inventory into sales
3.) Lower is better
What is Days Payable?
1.) DAYS IN PERIOD / [COGS/AP]
2.) Avg. time to pay AP
3.) Lower is better
4.) Useful with Days AR and Days Inventory
What is Operating Expense/Sales?
1.) TOTAL OPERATING EXPENSE / TOTAL SALES
2.) Useful in measuring & managing profit
What is Liabilities to Net Worth?
1.) TOTAL LIABILITIES / NET WORTH
2.) Measures leverage and capitalization
3). Too big is risk.
What is Total Liabilities to Tangible Net Worth?
1.) TOTAL LIABILITIES / TANGIBLE NET WORTH
2.) Too high is a risk.
Which financial ratios should increase in trend analysis?
1.) Sales
2.) Gross Margin
3.) Net Profit Margin
4.) Current Ratio
5) Quick Ratio
Which financial ratios should decrease in trend analysis?
1.) AR Turnover
2.) Inventory Turnover
3.) AP Turnover
4.) Liabilities / Net Worth
Which ratios should not be viewed by themselves?
1.) Return on Assets
2.) Return on Equity
What is Cash Flow>?
A company’s ability to pay for new debt out of historical profits + non cash expenses
What adjustments can be made to cash flow?
1.) add back lease tax benefits to historical earnings
2.) Add back potential earnings generated by the new equipment – projected cash flow
What is Cash Throw-Off?
1) traditional income statement analysis plus changes in the balances sheet
2.) measure the relation between sale/profit growth and management of operating assets/sales cycle
What are some negative Cash Throw Off a characteristics?
1.) Reduction current assets
2.) Reduction in fixed assets
3.)Increase in current liabilities
4.) Increase long term liabilities
5.) Increase in net worth
What are some positive Cash Throw Off characteristics?
1.) Increase current assets
2.) Increase in fixed assets
3.)Decrease in current liabilities
4.) Decrease long term liabilities
5.) Decrease in net worth
What are common credit risks?
1.) Deteriorating revenue base
2.) Decrease in profitability
3.) High risk industry
4.) Insufficient cash flow.
5.) tight liquidity
6.) High leverage
7.) Substantial distributions
8.) Terms too aggressive related to financial strength and collateral
What are three ways to manage risk?
1.) manage portfolio risk
2.) manage transaction risk
3.) educate your people
How can you manage portfolio risk?
1.) establish proper credit policy
2.) More conservative policy, more conservative approvals
How can you manage transaction risk?
1.) Shortening term
2.) Reducing amount financed through initial payments
3.) Add additional guarantors
4.) Security deposits
5.) Raise yield
What are some risks with Additional Collateral?
1.) Must determine if securing lease or guarantee and have docs refelect accordingly
2.) UCC does not perfect security interest in collateral. Prior liens most be removed.
What are some concerns with over structuring a lease?
Too much initial cash or too short a term put undue pressure on cash flow and could force payment issues.
What are some key consideration when reviewing a personal financial statement?
1.) Joint – means filed with someone else. All assets may not be available in a liquidation.
2.) global cash flow (guarantor and lessee) may paint a more comprehensive picture borrowers ability to repay.
When did credit scoring start?
1.) late 50’s early 60’s
2.) large consumer finance companies
Who is credited with founded credit scoring?
1.) Bill Fair and Earl Isaac
2.) FICO
What is the concept behind Credit Scoring?
1.) history repeats itself with respect to borrower behavior
2.) Look for “characteristics & attributes” similar to historical data pool
3.) Characteristics/attributes used to create a score
Hos is score used?
1.) rank records in terms of risk
2.) can id specific problems but can put a record in a risk pool
3.) Rank order and pooling does have a high level of accuracy in predicting delinquency and default
4.) adjustments can be made to transaction pricing and structure based on pool
How do you build a scorecard?
1.) review data from past borrowers to determine which characteristics are most use in predicting future behavior
2.) historical data MUST be of sufficient size to make analysis valid
3.) Need to review characteristics for both good and bad clients
4.) small business loans must look at both business and PG data
What is Regression Analysis?
1.) “regression to the mean”
2.) identify which combination of attributes best predicts potential problems
3.) Of may attributes, only a few may be meaningful
4.) most predictive attributes might be give more “weight”
How are Credit Scores used in making credit decisions?
1.) higher scores are typically better an represent lower risk
2.) Appove above a certain score
3.) review scores below cutoff to attempt to broaden the scorecard
4.) Below cutoff approvals can be used to test the model
What is the linear probability modelin Credit Scoring?
Assumes a linear relationship between probability of default and factors.
What is the logit model theory in Credit Scoring?
Assumes that the probability of default is logically distributed
What is the probit model theory in Credit Scoring?
Assumes the probability of default has a cumulative normal distribution
What are Neural Networks?
1.) credit scoring method used for commercial lending that is more heterogeneous than consumer lending
2.) uses artificial intelligence
3.) learns form experience
4.) newer technique criticized as being “ad hoc”
What are the benefits of Credit Scoring?
1.) quicker, cheaper and more objective
2.) may help lenders comply with regulation
What is a primary goal of the accounting profession?
Consistent treatment of like transactions to allow clarity in presentation and consistency in interpretation of financial statements prepared by various individuals or entities.
How did APB (Accounting Principals Board) fail?
Created Opinion #5 (Reporting of Leases in Financial Statements of Lessees) and Opinion #7 (Accounting for Leases in Financial Statements for Lessors) that ha different opinions and left lessors & lessees with conflicting rules.
What was FASB 13?
Financial Accounting Standards Board issued “Accounting for Leases” which was a comprehensive set of standards to be followed by lessors and lessees in accounting lease transactions.
What is Accounting Standards Codification?
Approved by FASB in 7/2009, a single source of of authoritative US accounting and reporting standards
What now governs lease accounting?
ASC 840
What is a Bargain Renewal Option?
a provision allowing lessee, at his option, to renew the lease for a rental sufficiently lower than the expected fair value of the property at the date the option becomes excercisable. It is reasonably assured the renewal option will be exercised.
What is a Bargain Purchase Option?
a provision allowing lessee, at his option, to purchase the property for a price sufficiently lower than the expected fair market value of the property at the date the option becomes excercisable. It is reasonably assured the purchase option will be exercised.
What are Contingent Rentals?
Rentals that represent increases or decreases in the lease payments made that result from changes in the factors on which lease payments are based occurring subsequent to the inception of the lease. Increases may occur due to increased construction cost or indexed interest rates.
What is Economical Useful Life of Leased Property?
At the inception of the the lease, the estimated remaining period during which the property is expected to be economically usable for its intended purpose by one or more users. This may be impacted by usage, technology and deterioration. Independent of lease term.
What is Residual Value of Leased Property?
Estimated fair value of the lease property at the end of the lease.
What is Executory Costs?
The costs such as insurance, maintenance and taxes incurred for the leased property, whether paid by lessor or lessee. Also include costs paid by lessee as guarantor.
What is Value of Leased Property?
The price at which the property could be sold at an arm’s length transaction by unrelated parties.
1.) normal selling price, net volume discounts, for a lessor who manufacturer/dealer
2.) Cost, net volume discounts for a lessor that is note a manufacturer or dealer.
What is Implicit Interest Rate?
The discount rate that, when applied to the minimum lease payments cause the aggregate present value at the beginning of the lease term to be equal to the fair value of the leased property to the lessor at the inception of the lease.
What is Inception of the Lease?
The date lease commitment.
What is Incremental Borrowing Rate?
The rate, at the inception of the lease, the lessee would have incurred to borrow, under like terms, the funds necessary to purchase the lease asset.
What is Initial Direct Cost (IDC)?
Costs incurred by lessor that are
1) to originate the lease in transactions with independent third parties that are required and would have occurred regardless of leasing
2.) certain cost incurred by the lessor
What is a Lease?
An agreement conveying right to use property, plant or equipment for stated period of time and rental payment.
What is Lease Term?
The fixed, non cancel-able term of the lease plus:
1.) period covered by bargain renewal options
2.) period covered by a renewal when a significant penalty for failure to renew exists;
3.) Ordinary renewal periods
4.) Renewal periods that precede a bargain purchase option.
5.) Renewal periods that are at the option of the lessor
6.) does not exceed term beyond when the bargain purchase option can be exercised.
What is Maximum Lease Payments?
All payments the lessee is obligated to make under the lease agreement (outside of executory costs)
1.) minimum rentals
2.) Lessee guarantee of the residual value
3.) Penalties for failure to renew.
4.) Calc for lessor to include guaranteed residual
What is a Non-Cancelable Lease?
A lease that is only cancelable upon:
1.) Occurrence of some remote contingency;
2.) Permission of lessor;
3.) Entrance into a new lease with the same lessor;
4.) Payment of a penalty in an amount that makes continuation of the lease reasonably assured.
What is Renewal or Extension of a Lease?
The continuation of a lease agreement beyond the original term, including a new lease where the lessee continues to use the same property.
What is Sale-Leaseback Accounting?
A method of accounting for transactions in which the seller-lessee records the sale , removes the property and related liabilities from its balance sheet, recognizes gain or loss from the sale and classifies the leaseback in accordance with proper lease accounting
What is Unguaranteed Residual Value?
The estimated residual value of the leased property exclusive of any portion guaranteed by the lessee or by a third party unrelated to the lessor. If the guarantor is related to the lessor, the residual value is considered unguaranteed
What are the three types of Lessor Financial Statements classification?
1.) Operating
2.) Direct financing (capital lease)
3) Sale-type (capital lease)
4) If lender is lending cash – typically capital lease
5) If lender is lending assets – typically operating lease
What dictates the proper treatment of a lease on the lessors books?
ASC 840. If any of the following are met at time of lease inception, capital lease treatment is required.
1). transfer of ownership at lease end;
2.) bargain purchase option;
3.) lease term >= 75% property economic useful life
4.) PV of payments > 90% of fair value (less tax credits)
If a criteria of ASC 840 is met, what additional criteria must be met to classify as a capital lease?
In addition to meeting an ASC 840 criteria, both of the following must be met to classify as capital lease:
1). collectibility is reasonably certain;
2.) No important uncertainties surround the amount of the non-reimbursable costs to be incurred by the lessor under the lease.
How should manufacturer account for a sale-type lease?
1.) take sale profit, or
2.) capitalize the expense as IDC
3.) Can’t to both
How should a lessor account for a direct finance lease?
Net investment (book value) in the lease is recorded as an asset on the balance sheet:
+Gross Investment
- Unearned Income
= Net Investment
What is Gross Investment?
The sum of all the min. lease payments plus the un-guaranteed residual value.
What is Unearned Income?
Is the gross investment less asset cost.
How is debt accounted for by lessor in a direct finance lease?
Debt incurred by lessor to acquire equipment remains on the balance sheet as long term liability
How is Unearned Income accounted for on the Lessor Income Statement?
Unearned income is amortized over the lease term so as to produce a constant periodic rate of return on the net investment.
What is Initial Indirect Cost (IDC)?
Could include fees paid to vendor/broker, internal sales commissions and other expenses incurred by lessor associated with transaction.
How is IDC accounted for on Lessor financial statements?
IDC incurred by lessor are capitalized, reduced from expense and amortized on a straight-line basis over over the term of the lease to offset income.
How should a Lessor account for residual values?
1.) review residual values annually
2.) If decline, determine if temporary or permanent.
3.) if permanent, value is to be revised and loss in the investment during the current period.
4.) Residual values are never adjusted up, even in cases of past losses.
What are a lessor’s required financial disclosures regarding direct finance leases?
1.) general description
2.) Future min. lease payments to be received (net of executory, non collectible expenses and profit)
3.) Unguaranteed residual value
4.) Unearned income
5.) Future minimum lease payments for each of the next five years
6.) Amount of unearned income included in income to offset initial direct cost charged against income for each period income statement presented
7.) Total contingent rental included in income for each period income statement presented
How should a Lessor account for an Operating Lease on its balance sheet?
1.) lease property is capitalized as cost under “investment in leased property”,
2.) Leased property is depreciated straight-line over the lease term, down to the residual value
How should a Lessor account for an Operating Lease on its income statement?
Rental income is recognized on operating leases in the period the payment is a receivable. If payments are not level (increasing or decreasing) they are recorded on a straight-line basis unless the alternative payment is more representative of property usage
What are a lessor’s required financial disclosures regarding operating leases?
1.) a general description describing leasing arrangement
2.) The cost (or carrying amount) of the property being leased
3.) Min. future rentals as of the balance sheet date and for each of the succeeding five years.
4.) Total contingent rentals
How may Lessor and Lessee testASC 840 differently?
1) may use different implicit rates to calc 90% FMV test
2.) Lessor includes residuals guaranteed by third parties and lessee does not when calc 90% FMV test
How should the lessee record a capital lease on its balance sheet?
1.) as an asset and an obligation;
2.) the obligation should be recorded at the lower of r value:
i.) PV of stream at the beginning of the stream (exclude executory cost)
ii.) the fair value of leased property
How should the lessee record a capital lease on its income statement?
During each lease term, each minimum payment shall be allocated between a reduction of obligation and interest expense.
What should a lessee’s financial statement disclose regarding a capital lease?
1.) gross amount of asset
2.) future min. lease payments as of the date of the balance sheet and each succeeding five years (exclude executory costs and profit)
3.) total contingent payments
4.) asset and related accumulated depreciation
5.) related obligation with classification into current and non current liabilities
6.) amortization charges
What should a lessee’s income statement disclose regarding an operating lease?
Rental payments on an operating lease shall be charged to expense over the lease term as is becomes a payable.
What should a lessee’s balance sheet disclose regarding an operating lease?
1.) Disclosure for all operating expense for current period.
2.) Disclosure for operating leases having initial or remaining lease terms in excess of one year and for each of the five succeeding years.
What are the three basis of accounting on which financial statements are created?
1.) accrual
2.) cash
3.) tax
What basis of accounting is required by GAAP?
Accrual
What is accrual based accounting?
1.) Revenue and expense are recognized in the period in which service is performed or goods are delivered, regardless of when payment is made.
2.) Matching of revenues and expenses
What is cash basis accounting?
Revenues and expenses are recorded when cash is received or paid.
What is tax basis accounting?
The preparer uses tax rules to dictate the recording of income and expense items, which may differ from the respective financing accounting methods
What are the benefits of accrual basis accounting?
1.) report a company revenue/expenses for a particular period of time
2.) report a company assets/liabilities for a particular period of time
3.) Provide insight into liquidity, leverage and allow insight as to whether they can accommodate more debt.
What are the shortcoming of cash basis accounting?
1.) may understate liabilities on balance sheet
2.) may overstate income on income statement
3.) not ideal for credit decisions
What are the three levels of assurance provided by financial statements?
1.) compiled
2.) reviewed
3.) audited
What are compiled financial statements?
Present management’s representations in financial statement format. The prepairer is not to verify accuracy of the information presented
What are reviewed financial statements?
Provide an additional level assurance. The accountant reviewed report offers reasonable assurances that there a no material modifications that should be made to the financial statements in order for them to conform with GAAP. Preparer of reviewed statements conduct various procedures, including ratio analysis and company interviews.
What is an audited financial statement?
1) Provide the greatest level of assurance. An unqualified auditor’s report purports that the financials are presented fairly, in all material aspects, the financial position of the company.
2.) Include test audits.
3.) evaluates controls
4). confirms external information
5.) evaluates for fraud
What is a qualified audited financial statement?
Audited statements that contain departures from GAAP or omitted disclosures may require auditor to qualify the report and address the effect of such departures on the financial position of the company
What are the components of a full disclosure financial statement?
1.) balance sheet
2.) income statement and Retained Earnings
3.) statement of cash flow
4.) Notes
5.) Optional supplementary informaiton
What is the purpose of the balance sheet?
Display assets, liabilities and equity accrued over the life of the business.
What is the purpose of the income statement?
Report Income minus expenses for a specific period of time.
How can financial statements be used to manage?
1.) Review statements over different periods of time can help management to see trends, strengths and weaknesses.
2.) Reviewing financial statements over longer period time, underwriters can better assess credit risk.
Describe a key element to understanding a balance sheet.
1.) Assets – Liabilities = Equity
2.) any increase or decrease on one side of the equation always creates a corresponding entry on the other side of the equation
What is a Heading?
Regarding elements of a balance sheet, the name of the business, type of statement and dd/mm/yyyy shown at the top.
What are Assets?
Regarding elements of a balance sheet, anything of value that is owned or legally due to the business. Assets are separated into categories; current assets, fixed assets and other assets.
What are current assets?
Regarding elements of a balance sheet, cash and liquid assets that can be converted to cash within a 12 month period.
What are Accounts Receivable?
Regarding elements of a balance sheet, a current asset representing the amount due from customers for payment of services or merchandise
What is Inventory?
Regarding elements of a balance sheet, a current asset including raw materials, work in process, and finished goods either manufactured or purchased for resale.
What are Marketable Securities?
Regarding elements of a balance sheet, a current asset consisting of interest or dividend-yielding holdings expected to be converted to cash within a year. Also called short term investments including stocks, bonds, CD’s and time deposits. Listed at their original cost.
What are Prepaid Expenses?
Regarding elements of a balance sheet, a current asset consisting of goods, benefits or services a business buys or rents in advance of use. Supplies, insurance and office rent are some examples
What are Long Term Investments?
Regarding elements of a balance sheet, assets consisting of long term assets that plan to be held for longer than a year and typically yield interest or dividends such as stocks, bonds or savings accounts
What are fixed assets?
Regarding elements of a balance sheet, assets similiar to buildings, land, machinery, equipment, office machines, furniture etc. Typically capitalized and amortized or depreciated over the useful life. Typically called plant and equipment.
What is Other Assets?
Regarding elements of a balance sheet, assets consisting of resources not listed with any of the other categories. Examples may include intangible assets, patent, trademarks etc.
What are Current Liabilities?
Regarding elements of a balance sheet, all debt and obligations payable within 12 months.
What is Account Payable?
Regarding elements of a balance sheet, a current liability consisting of amounts owed to suppliers for goods and services purchased in connection with business operations.
What is Short-Term Notes?
Regarding elements of a balance sheet, a current liability consisting of balance due to pay off short term debt for borrowed funds.
What is Current Portion of Long Term Debt?
Regarding elements of a balance sheet, a current liability consisting of the portion of debt that is payable within the next 12 months.
What is Interest Payable?
Regarding elements of a balance sheet, a current liability consisting of any accrued fees due for use of both short term and long term borrowings.
What is Taxes Payable?
Regarding elements of a balance sheet, a current liability consisting of amounts estimated by an accountant to have been incurred during the accounting period.
What is Accrued Payroll?
Regarding elements of a balance sheet, a current liability consisting of salaries and wages currently owned.
What are Long-Term Liabilities?
Regarding elements of a balance sheet, liabilities consisting of notes, contract payments or mortgage payments due over a period exceeding 12 months.
What is Equity?
Regarding elements of a balance sheet, also called net worth, equity is the claim of the owner(s) on the assets of the business.
What is Capital Stock?
Regarding elements of a balance sheet, equity consisting of the total amount invested in the business in exchange for shares of stock at values up to the par value.
What is Excess Paid In Capital?
Regarding elements of a balance sheet, equity consisting of the amount in excess of par value that a business receives from share of stock sold.
What is Retained Earnings?
Regarding elements of a balance sheet, equity consisting of the total accumulated net income minus the total accumulated dividends since the company’s founding.
What is Total Liabilities and Equity?
Regarding elements of a balance sheet, the sum of of these two categories which must equal assets.
What are Revenues?
Regarding elements of an income statement, all sources of trade revenues flowing into the business for services rendered or goods sold. Typically reported net of sales returns.
What is Cost of Sales?
Regarding elements of an income statement, represents the total costs of goods sold during the period. Services businesses generally do not have a COGS
What is Gross Profit?
Regarding elements of an income statement, also called gross margin, this figure is the difference between Revenues and COGS. Represents profit prior to expenses.
What is Operating Expenses?
Regarding elements of an income statement, these are the expenses related to conducting the business. They generally fall into two main catagories: selling or general/administrative.
What is Total Operating Income?
Regarding elements of an income statement, this represents Gross Margin less total operating expenses.
What is Other Revenue/Expense:
Regarding elements of an income statement, this represents income and expenses that are not generated by the usual course of business and are not considered extraordinary. An example would be interest expense.
What is PreTax income?
Regarding elements of an income statement, this represents Operating Income plus/less Other Revenue/Expense.
What is Net Income?
Regarding elements of an income statement, this figure represents the sum of all revenues minus the sum of all expenses. Commonly referred to as the “bottom line”
What is the major purpose of the Statement of Cash flows?
To show the sources and uses of cash from the beginning to the end of the period, and what caused the change.
What is the purpose of the Notes section?
Regarding elements of an income statement, this is key to developing an understanding of the accounting methods and polices applied by a business. Also report significant items to the reader. Also includes other details and schedules of long term debt.
What are Financial Relationships (Ratios)?
The interpretation of the relationships between any two figures is called financial analysis and can provide insight and answers to questions.
What is Current Ratio?
TOTAL CURRENT ASSETS / TOTAL CURRENT LIABILITIES. Measures liquidity or businesses ability to meet short term obligations with short term assets. Also called Working Capital Ratio. Higher is better. 2:1 is the benchmark
What is Quick Ratio?
[CASH + AR] / [CURRENT LIABILITIES]. Commonly called the Acid Test Ratio, rule of thumb is should be 1:1. Measures ability to pay current debt without future sales.
What is Debt to Equity?
[TOTAL DEBT] / [TOTAL EQUITY]. The measures the amount invested in the company vs. the amount invested by ownership. Too high is a risk and represents too much debt. Too low may mean a too-conservative management.
What is Return on Equity?
[NET INCOME] / [TOTAL EQUITY]. A measurement of ownership’s return on investment stated as a %. This is a measure of profitability and management efficiency.
What is Sales to Working Capital?
[NET SALES] / [CURRENT ASSETS/CURRENT LIABILITIES]. This shows how man y $’s are made per one $ of working capital. A low ratio may mean that working capital is not being used efficiently. A very high ratio may mean not enough working capital for the current high sales environment.
What is Net Profit Margin?
[NET INCOME] / [NET SALES]. A measure of profitability, this ratio shows how much net income, or net profit, is derived from every dollar of sales
What is Inventory Turnover?
[COST OF GOODS SOLD] / [AVERAGE INVENTORY]. Yields the # of times inventory turns in one accounting period.
[Beginning Inventory + Ending Inventory]/2 = Avg Inventory
What is Operating Expense Ratio?
[ANY OPERATING EXPENSES] / [NET SALES]. Best to identify each expense category’s economic efficiency.
What is Net Sales to Inventory?
[NET SALES] / [INVENTORY]. Also called the Sales to stock ratio, this formula results in a different figure from the Inventory Turnover. It is not a method of calculating physical turnover but rather the sales volume generated by current inventory as compared to other similar businesses.
What is Receivable Turnover?
[NET SALES] / [AVERAGE ACCOUNTS RECEIVABLES]. The higher the turnover, the faster the business is collecting.
[Beginning A/R + Ending A/R]/2 = Avg A/R
What is Parables Turnover?
[PURCHASES] + [AVERAGE ACCOUNTS PAYABLE]. The numbers of days a business will take to pay for purchases during an accounting period.
[Beginning A/P + Ending A/P]/2 = Avg A/P
What is Aging the Receivables?
A method of determining the quality of accounts receivable by listing the accounts length of time on the books (30, 60, 90 days etc.). Excess past dues reflect ineffective collections and poor management.
What is Amortization?
Gradual retirement of debt by even, periodic payments; also , the operation of expenses be written off during a fixed period.
What is Appreciation?
Any increase from the acquisition price of a fixed asset to the current appraised market value. For financial statement purposes, appreciation is not used for three principal reasons:
1.) Objectivity – which would require appraisals which are costly.
2.) Continuity – fixed assets are acquired for continuing operations and not resale;
3.) Conservatism – given a choice in values, an accountant would choose the more conservative.
What is Cash Flow?
The supply of money continuously received from operations and other sources and the supply continuously dispersed to pay expenses, including the payment of debt.
What is Depreciation?
An accounting assumption that holds that all fixed assets (with exception of land) deteriorate, wear out and become obsolete. The decline in value is called depreciation.
How is Depreciation Calculated?
Apportioning an assets original value, less any expected salvage value, over the expected useful life.
How is Depreciation reflected on financial statements?
1.) income statement – reflected as an expense
2.) balance sheet – reflected as book value (carrying cost)
What is Straight-Line Depreciation?
[ ACQUISITION PRICE – SALVAGE VALUE] / USEFUL LIFE
What is Average Cost Inventory Valuation?
TOTAL INVENTORY ACQUISITION COST / # of UNITS
What is FIFO Inventory Valuation.
First In First Out – Assumes that those items of inventory most recently acquired are sold before older inventory.
What is advantage of FIFO Inventory Valuation?
It reflects the most recent prices in inventory values.
What is LIFO Inventory Value?
Last In First Out – Assumes the most recent acquired are sold first. Ending inventory consists of older inventory prices.
What is the advantage of LIFO Inventory Valuation?
Reflects current inventory prices in Cost of Goods Sold calculation.
Inventory 1 $100, Inventory 2 $300, Inventory 3 is $500. 2 units are sold. What is FIFO COG and Valuation?
COGS = $400, Valuation= $500
Inventory 1 $100, Inventory 2 $300, Inventory 3 is $500. 2 units are sold. What is LIFO COG and Valuation?
COGS = $800, Valuation = $100
Inventory 1 $100, Inventory 2 $300, Inventory 3 is $500. 2 units are sold. What is Average Cost COG and Valuation?
COGS = $600, Valuation = $300
What is Liquidate?
To convert non-cash assets into cash; also to close up business by collecting all assets and paying all debts.
What is Negative Cash flow?
Cash received (income) < cash paid (expenses)
How will Lessee Accounting be changed with IFRS & FASB anticipated changes?
1.) Lessee’s will account for Operating Leases on their balance sheet (asset and debt) regardless of lease classification;
2.) The asset woudl be thevalue of the right to use the asset, the PV of the rental payments.
3.) Exception will be leases < 12 months in term
How will Lessor Accounting be changed with IFRS & FASB anticipated changes?
1) Sale-Type selling profit will be impacted;
2.) To be classified as sale-type, teh lease contact along (not residual) must transfer control of the underlying asset to the lessee
3) If not met, lease will likely be direct finance lease with revenue being realized over term of the lease
What did we learn via the 1984 Congressional Record of House int eh “Joint Explanatory State of the Committee Process”?
“…tax rules are generally not written in IRS code. Instead they evolved over years through a series of court cases and revenue rulings and revenue procedures issued by the IRS”
What is the “burden of proof” related to a true lease (tax)?
1.) Pass title;
2.) Bargain purchase option
3.) Term substantially equivalent to useful life
4.) Use 80% of useful life
5.) Entered solely to avoid tax.
6.) Minimize the lessor investment in the residual transaction.
How is Lessor’s Tax Treatment different if a lease DOES NOT pass “burden of proof”?
Would be considered a sale, not a lease and the lessor would realize rental income to the extent of the total lease payments exceed the equipment cost. Interest is amortized of the the life of lease.
How is Lessor’s Tax Treatment different if a lease DOES pass “burden of proof”?
Treated as True Lease. Rental payments are recognized as income and the leased asset is capitalized as an asset and depreciated. Must use tax, not book, depreciation method (i.e. useful lives)
What is Modified Accelerated Cost Recovery System (MACRS)
Enacted as part of Tax Reform Act of 1986, it is the predominate method for tax basis depreciation for assets (> 1987).
What is IRS Section 179?
1.) Allows immediate deductions for certain amounts of assets during the year of purchase.
2.) Allowed on both new & used.
3.) Intended to help small business and is phased out after a certain $ level of assets cost
4.) deduction amounts and $ levels for phase out have changed over the years.
5.) $500,000 level.
6.) Phases out $2MM to $2.5MM in assets purchased
What is Bonus Depreciation?
1.) Created by Job Creation and Worker Assistance Act of 2002
2.) Provides beneficial depreciation acceleration for lessors.
3.) 30% – 100% upfront depreciation in year of purchase followed by MACRS (vary over years)
4.) only available on NEW equipment
5.) 50% extened through 2019
Where is Personal Property Tax Assessed?
Equipment leasing companies are subject to sales & PPT requirements in the jurisdiction of where the equipment is located.
Are “net leases” treated differently from tax perspective?
Some lessor believe that they can delegate tax liability to the lessee via their lease agreement. Most government agencies don’t agree.
Why is sales tax complicated?
1.) require monthly, quarterly, semi annual or annual
3.) payment may be due upfront or over the stream
4.) certain equipment is exempt for sales tax
5.) sales tax vary per jurisdiction and update periodically
What is the process for filing ppt?
1.) lessor must pay if it held equipment on assessment date – therefore shroud include estimate in payoff requests.
2.)Multi-step. First rendition filed in taxing jurisdiction where equipment is located
3.) includes equipment type, cost, purchase date & location
4.) Taxing jurisdiction responds by sending a assessment notice to leasing company (asset adjusted for depreciation).
5.) A time period is provided to protest
6.) After review period, tax jurisdiction issues a bill
7) once billed, lessor may invoice lessee to collect