Glossary of Common Leasing Terms

Browse Below for a List of Commonly Used Terms: 
 
Note: Many of the terms below are defined in FAS 13 (or another FASB statement); such definitions are inside quotation marks, and followed by the statement paragraph number, plus the statement number if it is not FAS 13.
 
To conserve space and avoid violating "fair use" rules (since FAS 13 is copyrighted by the FASB; see ordering information below), less significant portions of some definitions are edited out; the gaps are shown with an ellipsis (…). Footnotes are excluded. Terms in bold type are defined elsewhere in the glossary. Follow the link for more information on accounting for leases.
 
Some of these definitions are changing in ASC 842/IFRS 16, the new lease accounting standards that take effect in 2019. We will be updating this glossary in the near future.
 

Financial Computer Systems takes the mystery out of accounting for leases. Using our EZLease software, you need not become a specialist in lease accounting, but can rely on us to answer all your questions and explain the best method of complying with the regulations that apply to your business.

 
 Bargain purchase option “A provision allowing the lessee, at [the lessee’s] option, to purchase the leased property for a price that is sufficiently lower than the expected fair value of the property at the date the option becomes exercisable that exercise of the option appears, at the inception of the lease, to be reasonably assured.” 
 Capital leaseA lease that meets one or more of the following criteria. These are the 7(a)-7(d) tests (so called because they are in paragraphs 7(a)-7(d) of FAS 13): (a) The lease conveys ownership of the property to the lessee by the end of the lease term. (b) The lease contains a bargain purchase option. (c) The lease term is equal to 75 percent or more of the estimated economic life of the leased  property.... (d) The present value at the beginning of the lease term of the minimum lease payments, excluding that portion of the payments representing executory costs..., equals or exceeds 90 percent of the excess of the fair value of the leased property to the lessor at the inception of the lease.… A lessee shall compute the present value of the minimum lease payments using his incremental borrowing rate unless ( i ) it is practicable for him to learn the implicit rate computed by the lessor and   ( ii ) the implicit rate computed by the lessor is less than the lessee’s incremental borrowing rate. If both of those conditions are met, the lessee shall use the implicit rate.” Tests (c) and (d) are skipped if the asset is in the last 25% of its economic life at lease inception. A capital lease is considered to transfer “substantially all of the benefits and risks incident to the ownership of property [and therefore] should be accounted for as the acquisition of an asset and the incurrence of an obligation by the lessee. … [T]he economic effect on the parties is similar, in many respects, to that of an installment purchase.” 
 Capital rateThe effective or imputed interest rate for a capital lease. If a lease is capital, an interest rate is calculated for purposes of breaking down every rent payment into interest and principal repayment. If the present value of the rents at the incremental borrowing rate (or implicit interest rate, if known and lower than the incremental rate) is less than the fair value of the leased property, the capital rate is the incremental borrowing rate (or implicit interest rate, if that was used). Otherwise, the rate is that interest rate which causes the present value of the rents to be equal to the fair value (which will be higher than the incremental or implicit rate). This causes the lease to be capitalized at (and have a gross asset and original obligation of) the lower of cost or market price.
 Capital rentsThe gross rent less any executory costs. The capital rents are present valued to determine the gross asset and original obligation for a capital lease.
 Capitalized cost reductionDown payment; for FAS 13 purposes, this is treated as a rental payment due when the lease starts.
 Contingent rentals“The increases or decreases in lease payments that result from changes occurring subsequent to the inception of the lease in the factors (other than the passage of time) on which lease payments are based.... Lease payments that depend on a factor directly related to the future use of the leased property, such as machine hours of use or sales volume during the lease term, are contingent rentals and, accordingly, are excluded from minimum lease payments in their entirety. However, lease payments that depend on an existing index or rate, such as the consumer price index or the prime interest rate, shall be included in minimum lease payments based on the index or rate existing at the inception of the lease; any increases or decreases in lease payments that result from subsequent changes in the index or rate are contingent rentals and thus affect the determination of income as accruable.” [FAS 29]
 Early terminationCancellation or termination of the lease agreement before the end of the lease term. The asset and obligation are removed from the books; the difference is a termination gain or loss on the income statement.
 Estimated economic life“The estimated remaining period during which the property is expected to be economically usable by one or more users, with normal repairs and maintenance, for the purpose for which it was intended at the inception of the lease, without limitation by the lease term.”
 Executory costs“[Those costs] such as insurance, maintenance, and taxes [incurred for leased property, whether paid by the lessor or lessee....]”
 ExpirationThe normal termination of a lease at the end of the lease term.
Fair value of the leased property “The price for which the property could be sold in an arm’s-length transaction between unrelated parties. The following are examples of the determination of fair value: (a) 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, reflecting any volume or trade discounts that may be applicable.... (b) 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.…”
 FASStatement of Financial Accounting Standards, typically followed by the statement number; issued by the Financial Accounting Standards Board. (Some people use the abbreviation SFAS or FASB instead of FAS.) FAS 13 is the primary statement regarding leases; it has been amended by FAS 17, FAS 22, FAS 23, FAS 26, FAS 27, FAS 28, FAS 29, FAS 34, FAS 71, FAS 77, FAS 91, FAS 94, FAS 96, FAS 98, and FAS 121. It has also been interpreted by several FASB Interpretations and FASB Technical Bulletins. Compliance with generally accepted accounting principles (GAAP) is based on these statements plus the accumulated body of prior accounting principles, and is required for all corporations with publicly held stock or debt.
Financial Accounting Standards Board (FASB) The chief accounting rule-making body in the United States; a part of the Financial Accounting Foundation (along with the Governmental Accounting Standards Board, which determines accounting rules for governmental bodies). Statements issued by the FASB are themselves called FASBs by some people; this guide refers to statements as FAS and the statement number (e.g., FAS 13).
 Governmental Accounting Standards Board (GASB)The chief accounting rule-making body for United States state and local governmental entities; a part of the Financial Accounting Foundation (along with the Financial Accounting Standards Board, which determines general accounting rules). Entities subject to GASB rules include public benefit corporations and authorities, public employee retirement systems, and governmental utilities, hospitals, colleges, and universities, as well as states and political subdivisions. As of 2017, GASB rules regarding leases are essentially the same as the FASB’s rules, but a new GASB standard for leases is expected to take effect in 2020.
 Gross assetThe original asset value of a capital lease, equal to the present value of the capital rents at the capital rate. It is the lower of the fair value of the leased property or the present value of the rents at the incremental borrowing rate (or implicit interest rate, if known and lower than the incremental rate). The asset is depreciated over the life of the lease (or over the economic life, if the lease conveys ownership or has a bargain purchase option).
 Gross rent The entire rent payment due for each payment period, including executory costs but excluding contingent rentals.
 Guaranteed residual“Any guarantee by the lessee or any party related to the lessee of the residual value at the expiration of the lease term, whether or not payment of the guarantee constitutes a purchase of the leased property. When the lessor has the right to require the lessee to purchase the property at termination of the lease for a certain or determinable amount, that amount shall be considered a lessee guarantee....”
Implicit interest rate “The discount rate that, when applied to (a) the minimum lease payments, excluding that portion of the payments representing executory costs to be paid by the lessor, together with any profit thereon, and (b) the unguaranteed residual value accruing to the benefit of the lessor causes 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.…” This is often not known by the lessee, since the unguaranteed residual value is often not stated.
 Incremental borrowing rate“The rate that, at the inception of the lease, the lessee would have incurred to borrow over a similar term the funds necessary to purchase the leased asset.” 
 International Accounting Standards Board (IASB)Similar to the FASB, the body responsible for setting accounting regulations for Europe and numerous other countries around the world. The IASB standard for leases is IAS 17.
 Lease“An agreement conveying the right to use property, plant, or equipment (land or depreciable assets or both) usually for a stated period of time.” 
 Lease termThe fixed noncancelable term of the lease plus:
(a) all periods, if any, covered by bargain renewal options,
(b) all periods, if any, for which failure to renew the lease imposes a penalty on the lessee in such amount that a renewal appears, at the inception of the lease, to be reasonably assured,
(c) all periods, if any, covered by ordinary renewal options during which a guarantee by the lessee of the lessor’s debt ... or a loan from the lessee to the lessor directly or indirectly related to the leased property is expected to be outstanding,
(d) all periods, if any, covered by ordinary renewal options preceding the date as of which a bargain purchase option is exercisable, and
(e) all periods, if any, representing renewals or extensions of the lease at the lessor’s option;
 Lease vs. BuyThe process of determining whether it is more economically advantageous to lease or to buy an asset.
 LesseeThe user of a leased asset, who pays the lessor for use of the asset.
 LessorThe conveyor of the right to use a leased asset, who receives rent from the lessee for that right. The lessor may own the asset, or may lease the asset from another lessor, in which case the secondary transaction is called a sublease. It does not matter to the lessee, for accounting purposes, whether the lessor owns or leases the asset.
 Leveled rentIf an operating lease has scheduled rent increases (or, rarely, decreases), rent expense is recognized “on a straight-line basis over the lease term unless another systematic and rational allocation basis is more representative of the time pattern in which the leased property is physically employed.” [FASB Technical Bulletin 85-3, For instance, if rent is increased due to increasing availability of floor space in a building lease, it may be appropriate not to level the rent. On the other hand, a rent holiday or a later increase in rent due to an expectation of inflation must be leveled. The difference between cash rent and rent expense creates a deferred liability (if cash rent to date is less than expense, the normal situation) or a deferred asset (if cash rent to date is greater than expense, perhaps due to a bargain renewal option near the end of the lease).
 Minimum lease payments From the standpoint of the lessee:The payments that the lessee is obligated to make or can be required to make in connection with the leased property. (Contingent rentals shall be excluded from minimum lease payments. [FAS 29,) ... Minimum lease payments include the following: (a) The minimum rental payments called for by the lease over the lease term. (b) Any guarantee by the lessee or any party related to the lessee of the residual value at the expiration of the lease term, whether or not payment of the guarantee constitutes a purchase of the leased property. … (c) Any payment that the lessee must make or can be required to make upon failure to renew or extend the lease at the expiration of the lease term, whether or not the payment would constitute a purchase or the lease property. ...” 
 Month-to-month leaseA lease which can be cancelled at any time without penalty (or without a penalty significant enough to impel continuation). Month-to-month leases do not fall under the reporting requirements of FAS 13; you simply need to report the rent paid during each fiscal period. (These leases tend to be very expensive if maintained for more than a few months; often a year’s rent is greater than the cost of the item leased.)
 Negative amortizationIf a capital lease has a rent holiday or a period of very low rents, the rent paid may not be sufficient to pay the interest that accrues on the remaining obligation during that period. In such a case, the obligation increases rather than decreases, as the unpaid interest is added to the obligation balance. This is called negative (principal) amortization. The obligation may become larger than the original obligation, but is paid down later in the life of the lease.
 Operating leaseAny lease that does not meet any of the FAS 13 paragraph 7(a)-7(d) criteria; that is, any lease that is not a capital lease.
 Payment periodThe frequency with which rental payments are made. Most leases are paid monthly, but some are paid quarterly, semiannually, annually, or more unusual period lengths. Most leases are paid in advance, but some (most often real estate leases) are paid in arrears, which slightly alters the present value of the rents.
 Rent holidayA period during which no rent is due, sometimes offered at the beginning of a lease as an inducement to enter into the lease agreement. If the rent holiday comes during an optional renewal period, it is considered a "bargain renewal option" and all periods up to and including the holiday are part of the lease term.
 Rent stepA series of equal rental payments made once every payment period.
 Sale/leasebackA transaction in which an owned asset is sold to a financing company, which then immediately leases the asset (usually real estate) back to the seller. This enables the seller to receive cash immediately for the asset and often remove it from the books. However, sale/leaseback transactions must be structured correctly under FAS 98 to avoid "continuing involvement" that would cause the transaction to be effectively voided for financial statement purposes. Further, if the resulting lease is capital, most of the financial statement advantages are lost.
 SubleaseLeasing out an asset leased from someone else. The existence of a sublease means that three different parties are involved: the original lessor, who owns the asset and receives rent; the lessee/sublessor, who pays the lessor rent and receives rent from the sublessee; and the sublessee, who actually uses the asset and pays rent. A sublease may be for just a portion of the asset originally leased. If the original lease (also called a prime lease) is operating, the sublease is always operating for the sublessor; if the original lease is capital, the sublease may be capital or operating for the sublessor, depending on its terms. It does not matter to a lessee for accounting purposes whether he is ultimately a lessee or a sublessee; the accounting on the lessee side is the same no matter whether the lessor owns or leases the asset.
 SublesseeRecipient of an asset in a sublease transaction, who pays rent to the sublessor.
 Sublessor Holder (lessee)of an original lease on an asset, who then leases it out to a sublessee under a sublease. If the original lessee lease is operating, the sublease is operating; if the original lease is capital, the sublease may be operating or capital, depending on its terms. If it is capital, the original lease's asset is replaced with a receivable for the incoming rent stream.
 Termination gain or lossThe difference between the asset and the obligation at the time a capital lease is terminated. If the net asset at date of termination is greater than the remaining obligation, the difference is taken as a loss; if the obligation is greater (which is the normal case when a lease is early terminated), the difference is taken as a gain. The gain or loss may be offset by a cancellation penalty or, if the asset is purchased, by setting it up as an owned asset. An operating lease may have a termination gain or loss if it has scheduled rent increases resulting in a deferred liability or asset.
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.”  This is used to determine the implicit interest rate, but is typically not known by the lessee. If the unguaranteed residual value is not known, the implicit rate is not used in lessee accounting for the lease.
 
 
 
Copies of the complete FAS 13 document are available from:

 
Financial Accounting Standards Board
401 Merritt 7
P. O. Box 5116
Norwalk, CT 06856-5116
(203) 847-0700
 
The original pronouncements (without incorporating later changes) are available at the FASB web site.
 
Financial Computer Systems is not affiliated with the FASB.