1 ELFA Annual Convention October 2011 Lease Accounting Changes—Understanding the Lessee Impact and Strengthening Your Lessee Relationship

22 Agenda Project Timeline Overview: Proposed Lessee Models Potential Impacts Strategic Considerations Remaining Advocacy Issues

33 Project Timeline ED Issued August 2010 Redeliberations Jan Ongoing Comment Letters Dec 2011 Timeline in not fixed Dependent upon progress made and changes to new ED Effective date uncertain, tied to revenue recognition – likely to be 2015 or 2016 Outreach Final Standard 2013 Comment Letters T+120 Days New ED Issued 2 QTR 2012 Draft New ED 1 QTR 2012 Re-deliberate 3/4 QTR 2012

44 Proposed Accounting Models – Lessee and Lessor Lessor Models Lessee Right-of- Use Model Recognize “right-of-use” asset Recognize liability to make estimated future lease payments “Right to use” leased property Lease payments Recognize right to receive estimated future lease payments + residual asset Recognize partial sales- type gross profit Recognize right to receive estimated future lease payments + residual asset Recognize partial sales- type gross profit Derecognize leased property R&R Model Operating Lease Model (Short term leases only) Operating Lease Model (Short term leases only) Leveraged lease eliminated PV estimated rents including interim rents, bargain renewals, value of RVGs P&L cost front ended = amortization of ROU asset + imputed interest No rent expense Bifurcate or capitalize bundled rents

55 Redeliberations The Boards received nearly 800 comment letters, held public outreach meetings, and met several times with the Leasing Working Group. Main issues considered during redeliberations include: –Definition of a lease – fewer contracts will be leases –Lease term - simplified and moved back to current GAAP –Variable lease payments – simplified and limited capitalization –Options - simplified and moved back to current GAAP –Lessor accounting models – one basic DFL-like model plus short term lease model Eliminates leveraged leases Eliminates operating lease accounting for all but short term leases Sales-type gross profit accounting for all leases/residual portion deferred –Bundled full service leases – bifurcate service portion to avoid capitalization –Lease modifications, reassessments –Lessee cost allocation – front ends lease costs

66 Lessee People & Change Impacts Due to persuasive organizational change there is a need for a strong project management office with an effective governance structure and communication protocols Impacted departments will need appropriate communication and training to understand their role, the impact to their job responsibilities and their level of involvement in the ongoing support of the conversion project and ongoing accounting Departments impacted outside of General Accounting and Financial Reporting will likely include Business Segment Management, CFO, Legal, Real Estate, Treasury, Internal Audit, IT, Tax, Budgeting, Regulatory, Contract Management, and Forecasting Broad Impact on Lessees of Proposed Lease Accounting Standards Changes Lessee Systems & Processes Impacts Existing systems likely do not have sufficient functionality to handle new requirements of calculating right-of-use assets & lease obligations Transition will require an inventorying of all leases across an organization, potentially including contracts not previously accounted for as leases (e.g., contract manufacturing, IT outsourcing arrangements) Once leases are inventoried, physical documents will be needed to collect lease terms for every lease for input to a lease accounting system Expanded data needs may necessitate a need for forecasting and other systems Increased management judgment will elevate financial reporting risk, and will require changes to process documentation and SOX 404 testing Lessee Business Impacts Significant financial statement changes for lessees: – Increase in ROU & deferred tax assets impacts ROA calculations – Increase in liabilities impacts capitalization & debt to equity calculations – Inclusion of additional contingent rents will accelerate expense recognition – Rent expense replaced by amortization & interest increases EBITDA – Front ended expense pattern = earnings,capital issues & cost reimbursement issues – Loan covenant breaches due to changes in GAAP treatment Management may choose to review buy versus lease decisions Management may choose to evaluate the need to renegotiate current lease terms Lessee Accounting and Reporting Impacts Transition will be a major project Increased management judgment (e.g., lease term, options, contingent rent, service components,, etc.) Increased level of effort & financial reporting volatility due to ongoing remeasurement New “right of use” asset subject to impairment Added complexity in calculating book vs. tax differences – new def tax asset Need to significantly amend accounting policies and procedures Increased disclosure requirements Initial valuation of opening balance sheet and preparation comparative periods Need to support transition and ongoing external audit requirements

77 Lessor People & Change Impacts Accounting staff has to learn the new rules and transition rules Sales staff needs to know the new rules to respond to customer objections and questions Products need to be reviewed for changes to maintain their viability under the new rules (e.g. bifurcating service portion of full service leases, interim rent policies) Existing target markets need to be reviewed New products need to be developed Strategies to deal with existing leveraged lease portfolio Broad Impact on Lessors of Proposed Lease Accounting Standards Changes Lessor Systems & Processes Impacts Existing systems likely do not have sufficient functionality to handle new requirements of calculating PV receivable, residual and revenue recognition Transition will require data collection for all leases for input to a lease accounting system Lessor Business Impacts Significant financial statement changes for lessors: – Leveraged leases grossed up, earnings flatter, ROAs reduced, capital hit for accounting change adjustment – Operating leases, sales-type lease rebooked and new sales-type leases create new revenue recognition patterns – Inclusion of additional contingent rents will mean remeasurement and adjustment – Review residual insurance needs – Review existing securitizations for changes in presentation (e.g., residual guaranteed residuals are not financial assets) Lessor Accounting & Reporting Impacts Transition will be a major project especially for leveraged leases Transition will impact capital, the balance sheet and forecasts – leveraged leases, former operating leases and sales-type leases Increased management judgment (e.g., lease term, options, contingent rent, service components,, etc.) Increased level of effort & financial reporting volatility due to ongoing remeasurement Need to amend accounting policies and procedures New disclosure requirements Need to support transition and ongoing external audit requirements

88 Business Reasons for Leasing Reason for LeasingDetailsStatus After Proposed New Rules Raise CapitalAdditional capital source, 100% financing, fixed rate, level payments, longer terms Still a major benefit versus a bank loan especially for SME & non-investment grade lessees with limited sources of capital Low cost capitalLow payments/rate due to tax benefits, residual & lessor low cost of funds Still a benefit versus a bank loan Tax benefitsLessee can’t use tax benefits & lease vs. buy shows lease option has lowest after tax PV cost Still a benefit Manage assets/residual risk transfer Lessee has flexibility to return asset Still a benefit ServiceOutsource servicing of the leased assets. Still a benefit ConvenienceQuick & easy financing process often available at point-of-sale Still a benefit RegulatoryCapital issuesPartial benefit if the PV < cost of the asset, S/B true for hi residual assets w tax benefits AccountingOff balance sheetPartial benefit if the PV < cost of the asset, S/B true for hi residual assets w tax benefits

99 Impact by Lessee Type Lessee typePotential impact Investment grade/large companies Some negative impact as leases often accounting focused, have more sources of capital, more analytical staff, loss of leveraged lease product increases lease costs Non-investment grade/small & medium sized Less impact as source of capital is prime reason for leasing, fewer sources of capital, level payments & 100% financing conserves cash, less concerned about balance sheet optics, less staff to analyze lease and less analytical Municipal/tax exemptNo change in municipal market as GASB, not FASB, issues rules and operating leasing appears to be retained by GASB, tax exempt leasing offers lowest cost, leasing avoids issuing debt with all its constraints

10 Impact by Asset Type Asset typePotential impact High residual – vehicles, aircraft, rail, construction, agriculture, medical, material handling PV of rents (capitalized amount) significantly lower than cost of equipment = still some accounting benefit Low residual – computers, copiers, faxes, office furniture and equipment PV of rents (capitalized amount) closer to cost of equipment = little accounting benefit, interim rents (common in this segment) capitalized revealing a formerly ignored cost, when lease renewed must be rebooked raising attention to renewals which currently often occur without detection, trade ups (on books) get higher scrutiny

11 Impact by Lessee Lease Type Lessee lease typePotential impact Capital leases – Bargain PO/Auto title transfer No change but now accounted for as a purchase and a loan. Use ROU method – capitalize PV of rents Capital leases – Useful life/PV test Use ROU method – capitalize PV of rents Operating leasesUse ROU method – capitalize PV of rents, Short term lease election to still use operating lease accounting Synthetic/split-TRAC/fleet leases Use ROU method – capitalize PV of rents and the likely payment under residual guarantee Bundled full service leaseBifurcate the bundled payment or capitalize full value Muni leaseStill an operating lease

12 P&L Impact by Lessee Lease Term Lease Term First Year Increase in Lease Cost – Proposed vs. Current GAAP 3 Years 7% 5 Years 12% 10 Years 21% 15 Years 26% 20 Years28%

13 Capitalized Value by Lease Type Lease TypeTerms Estimated Capitalized Value PC lease 36 mos, 2.76% pmt, FMV with 15 day interim rent 91% Fleet lease12 mos, 2.5% pmt, 76% RVG (split TRAC) 29% Construction equipment lease 36 mos, 1.6% pmt, FMV, 50% residual 52% Cat Scanner lease60 mos, 1.5% pmt, FMV, 20% residual 77%

14 Impact by Lessor Lease Type Lessor lease typePotential impact Leveraged leasesEliminated. Existing leases grossed up on balance sheet, negative earnings adjustment charged to equity, future earnings “flatter”, ROAs/ROEs sub- standard. Alternative partnerships structures more costly to lessee and may be too complex for smaller deals and certain asset types. Direct finance leases No change but now called “receivable & residual” (R&R) method. Has same income pattern as current direct finance lease method. Guaranteed residual guarantee is not a financial asset. Operating leasesN/A except for short term leases. Good news for lessors as all but short term leases are R&R leases. Better earnings pattern. No need for residual insurance to turn operating leases into direct finance leases. Guaranteed residual guarantee is not a financial asset. Sales-type leasesAll but short term leases get gross profit up-front as in current sales-type lease accounting except the portion of gross profit related to the residual is deferred. Those lessors with high residual assets that were not direct finance leases under the old rules will get some up-front gross profit. On the downside lessors with low residual assets will have some up-front profits deferred. No need for residual insurance for accounting reasons.

15 Strategic Considerations New products Revise products Markets – emphasize/de-emphasize Customer service Disclose service components of full bundled lease payments Provide lessee accounting information Sales training Understand proposed rules Talking points Dealing with objections

16 Remaining Advocacy Issues Please be sure to comment when new ED is issued For details see IssueDesired outcomeBasis for request Lessee cost patternMaintain current straight line average rent expense for operating leases Reflects economic effects of an executory contract Matches revenue with costs in rent reimbursement scenarios Matches tax and legal view Avoids bank capital adequacy issues Leveraged leasesGrandfather existing deals Retain some form of leveraged lease accounting Reflects economics of the transaction Avoids capital adequacy issues Reduces lease rates Sales type gross profits deferred in proportion to residual risk retained Allow residual guarantees and insurance to be considered in the profit calculation A guarantee/insurance changes the residual’s nature to a financial asset Sale leasebacks with a non bargain purchase option are considered a financing The presence of a non bargain purchase option should not negate sale treatment All the risks and most of the rewards in the asset’s residual value have transferred to the buyer indicating that a sale has taken place The definition of the lease term for lessees is not clear The term should include only renewals that are bargains or are a compulsion issue Non bargain or non compulsory renewals are not obligations at lease inception. Equipment lessors in medium term leases where the equipment is leased several more times must use the Receivable & Residual method Lessors in the “operating lease” business should get investment property treatment as real estate lessors do Except for the fact that their leased assets are not real estate they otherwise meet the definition of investment property Operating lease accounting best reflects the economics of their business

17 Q&A Questions? Answers???