Disclaimer These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice. The views expressed.

ASC 842- Leases Lease Accounting and Operational Implications
Tim Shepard Senior Manager, Financial Accounting Advisory Services Ernst & Young LLP November 18, 2016

Disclaimer These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice. The views expressed by the presenters are not necessarily those of Ernst & Young LLP. This presentation is © 2016 Ernst & Young LLP. All Rights Reserved. EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US.

Agenda Lease Standard Overview Practical expedients/policy elections
Practical considerations What are your next steps to evaluate readiness for lease accounting change

Leases standard overview

Overview Where are we now?
The FASB issued ASC 842 on February 25, 2016. The standard replaces nearly all existing US GAAP guidance on leases: Virtually every industry is affected. The standards eliminate real estate specific provisions. For lessees, all leased assets will go on the balance sheet subject to short-term lease exemption. Minimal change for lessors. Both standards are principles based and will require entities to use more judgment and make more estimates than under current guidance. The effects on financial statements, business processes and internal controls will be significant for some entities. Data collection will likely be an issue for non-real estate leases. Speaker notes: Provide the client an update on significant revenue recognition related events from the FASB, TRG and the AICPA.

Overview Effective date– public and certain not-for-profit entities
FY 2017 and prior FY 2018 FY 2019 FY 2020 (year of adoption) FY 2021 and beyond Modified retrospective Reporting Annual & Interim FS Legacy GAAP Legacy GAAP Legacy GAAP Before adoption Footnotes SAB 74 disclosures (including transition method and impact) Presented in FY 2020 financial statements Reporting Annual & Interim FS New GAAP New GAAP New GAAP After adoption Footnotes ASC 250 Expanded Expanded Cumulative catch-up adjustment at July 1, 2018 Full retrospective adoption is prohibited. An entity that adopts ASU before it adopts ASU , Revenue from Contracts with Customers (Topic 606), may need to apply certain concepts in ASC 606 in accounting for the leases.

Overview Right-of-use model
9/25/2017 Overview Right-of-use model Right to use an identified asset Lessee Financial obligation to make lease payments Lessor Lease classification Lease classification Finance Operating Sales-type Direct financing Operating Recognize right-of-use (ROU) assets and lease liabilities for most leases Recognize expense similar to legacy GAAP Similar to legacy GAAP with some changes Leveraged lease accounting eliminated prospectively

Overview What makes transition to the new leases standard complex?
The new leases standard will continue to require significant judgments and estimates. However, many of these judgments and estimates may receive scrutiny because of the financial statement impact and additional disclosures. Input from: Finance and accounting Treasury Corporate real estate Lease procurement Supply chain Performance Transformation Internal audit Legal Information technology Tax ERP Determination of: Lease-related assets and liabilities Subsequent measurement Judgments and estimates of the following: Is it a lease? Are there non-lease components in the contract? What is the lease term, considering renewal, termination and purchase options? Are there variable lease payments and residual value guarantees? What is the lease classification? What is the discount rate? Does the transaction qualify for sale- leaseback accounting? How do you evaluate lessee involvement in asset construction? The judgment and estimates required under the proposals would demand in-depth knowledge of the business and an understanding of the intended use of the leased asset. Therefore, substantial involvement from people outside of the accounting department also would be required Financial/accounting – lease data, lease accounting process Treasury – discount rate (lessee only) Corporate real estate/Lease administration – procurement process, lease data Business operations – procurement process, intent/use of asset, process Legal – lease agreements, procurement process IT – changes to systems (calculations, new accounts, new financial statement presentation and disclosure) Tax – impact consideration (tracking deferred tax assets/liabilities, impact on state/local/property/sales tax) The new leases standard would continue to require significant estimates and judgments across a company. However, many of these estimates and judgments may receive scrutiny because of the balance sheet and income statement impact Companies may challenge whether an arrangement meets the definition of a lease when arrangements have substitution rights and where the potential economic benefits are shared by numerous parties There may be greater scrutiny to evaluate whether the portfolio of lease arrangement is complete due to arrangements that may have an embedded lease component. The trend for business transactions seems to be moving to arrangements that provide just-in-time rights to use an asset bundled with other goods and services whereas accounting requires separation of these components. Identifying non-lease components of contracts may change practice for some lessees. Today, entities may not focus on identifying lease and non-lease components because their accounting treatment (e.g., the accounting for an operating lease and a service contract) is often the same. Lessees may not focus on the incremental borrowing rate today for many leases that are not anywhere close to meeting the capital/finance lease classification. Companies that have not been carefully applying existing guidance will have the most work in implementing the new guidance – may not have an inventory of all leases and may not be able to take advantage of the transition reliefs. Is the necessary level of cross-functional support in place for the project?

Big picture: new leases accounting standard On the surface
New qualitative and quantitative disclosure requirements, including significant assumptions and judgments, lease maturity analyses reconciled to lease liability, lease expenses by types, weighted average discount rate, etc. US GAAP pattern of rent expense recognition should not change materially. Companies will recognize assets and liabilities for virtually all lease arrangements. Operating leases “on balance sheet” Income statement Disclosures Companies will likely see significant changes to financial metrics, KPI and capital structure, including return on assets, debt to equity, interest coverage, etc. Debt and other financial covenants may need to be adjusted. Financial ratios MH – better graphics

New leases standard Risks and considerations
Area Risks or considerations Adoption risk Definition of a lease An identified asset could be either explicitly or implicitly specified in a contract and can be a physically distinct portion of a larger asset (e.g., designated space in a medical office building). Health entities must determine if the customer can make and change the relevant decisions about how and for what purpose an identified asset is used, such as when, where and whether the asset is used. Low Medium Lease vs. non-lease components Lease contracts may include lease and non-lease components (e.g., contract with a supplier for both equipment and medical supplies necessary to use the equipment). Allocating contract consideration to the lease and non-lease components may be difficult for some entities. Unlike current standards, executory costs such as insurance and taxes will be included in lease payments. High Lease re-assessment Unlike current standards, a change to the lease term will result in re- measurement of the right-of-use asset/liability. Lease classification Although bright lines have been removed, the criteria are largely expected to remain the same. Build to suit The new standard has eliminated most of the complex rules associated with build-to-suit leases and replaced them with a model based on control. De-recognition upon transition. Financial statement impact Lessees will recognize a right-of-use asset and a lease liability for all leases other than short-term leases. Impairment will have to be considered for operating lease ROU asset balances Transition and disclosure The modified retrospective transition approach requires the restatement of prior year comparatives. Expanded disclosures. 2 3 4 5 6 7 8 9 10 1 11 8 10 4 High Medium Low 11 Financial statement impact 2 7 3 1 9 5 6 High Medium Low Process/systems impact High adoption risk Medium adoption risk Low adoption risk

Practical expedients/policy elections

New leases standard Transition – practical expedients
Lessees and lessors are permitted to make an election to apply a package of practical expedients that allow them not to reassess: Entities are also permitted to make an election for all existing leases to use hindsight when determining the lease term (i.e., evaluating a lessee’s option to renew or terminate the lease or to purchase the underlying asset) and assessing impairment of ROU assets (lessees only). Use of hindsight election may be elected separately or in conjunction with the package of practical expedients above. Certain disclosures are required in accordance with ASC 250, Accounting Changes and Error Corrections. Whether contracts are or contain leases Lease classification Whether IDCs quality for capitalization Apply to all expired or existing leases as a package Section 9.2.2

New leases standard Key policy elections
Determining whether or not to split lease and non-lease components (by underlying asset class) Discount rate to apply (incremental borrowing rate vs. RFR) Short-term lease exception policy (by underlying asset class) Section 9.2.2

Practical considerations
Section 9.2.2

Practical considerations Scope and definition of a lease
Entities need internal processes, controls and systems in place to … Does the entity use a standard lease or service contract, or do the form and content vary? Does the entity operate in a decentralized or centralized environment? … verify the completeness of their portfolio of leases … evaluate whether a contract is or contains a lease Which type of arrangements does an entity have that could be affected by the revised definition of a lease? How does an entity plan to identify any necessary changes? Will management be required to make more judgments when evaluating contracts? Section 9.2.2

Practical considerations Lease administration and lease accounting
Real estate Fleet (auto/ transportation) IT manufacturing Contract Office furniture and fixtures Manage lease payments, including CPI increases, variable payments and CAM adjustments Exercise lease term options (i.e., renewals, termination and purchase options) or lease amendments End of term: return leased asset Lease procurement, lease vs. buy, lease abstraction Lease administration Re-assessment and re-measurement where necessary Lease accounting Section 9.2.2 Determine whether arrangement is a lease Determine lease classification Calculate new lease accounting requirements General ledger Financial statement presentation and disclosure New system for lease accounting? New module? Legend Some impact Significant impact New

Practical considerations Which information should be collected for lease accounting?
Lease commencement date Lease expiration date Renewal option(s) Lease payment terms Lease incentives related to renewal Option exercise evaluation Termination option(s) Option date Payment amount Purchase option(s) Lease payments Fixed payment excluding consideration allocated to the non-lease components of the contract Free rent/rent credit Variable payment – index Variable payment – performance/usage Payment frequency Lease classification (fair value and economic life of the leased asset) Initial direct cost Lease incentives Residual value guarantee Discount rate Prepaid/accrued lease-related balance Section 9.2.2

What are your next steps to evaluate readiness for lease accounting change?
Section 9.2.2

Suggested actions Lease accounting change journey
4. Implement new accounting policies, processes, controls and systems, as well as changes to financial statements and disclosures 1. Understand current state of leasing activities (e.g., lease procurement, administration, and accounting and reporting) Current state Future state 3. Design solution for accounting change (e.g., new accounting policies, processes, controls and systems) to capture new lease data requirements and understand financial statement impact Section 9.2.2 2. Identify changes resulting from the new leases standard (e.g., data gaps, processes, controls, systems and tax) 5. Transition to the new leases standard Understand the new leases standard

Suggested actions Transition requires organizational change and alignment
1. Understand current state 2. Identify changes resulting from the new lease standard 3. Design solution for accounting change 4. Implement 5. Transition 2 weeks 3-4 months 3-4 months 9-12 months 9-12 months Current-state Lease Change Journey Future-state IT Enablement Management assumptions supporting financial reporting New accounting policies, processes, controls, systems and tax Identify key contract terms required for both administration and financial reporting Additional abstraction and/or electronic data transfer Lease systems for equipment and real estate Electronic data Agree lease arrangement scope Apply ASC 842 Lease environment Lease contracts Lease admin system(s) Excel files Procurement and cost center databases Section 9.2.2 Analyze and decide , Find, Abstract, Cleanse, Transform, Measure

Suggested actions Establish project management and planning activities (e.g., governance, objective, timeline and resource identification). Understand the requirements of the new leases standard. Understand the lease-related activities throughout the organization and perform a current state readiness assessment for the new leases standard. Evaluate changes to lease-related activities as a result of the new leases standard, including changes to accounting policies and procedures. Perform an impact assessment to understand the magnitude of the changes to the company from both a financial statement and business perspective. Design a plan for transitioning to the new leases standard, including accumulation of lease data. Section 9.2.2

Suggested actions Identifying complete population of leases
Key questions to ask: Is there a centralized procurement process for leases? Are there dollar thresholds for that which needs to go through procurement? If lease approval does not go through central procurement, who has authority to enter into a lease? Which group(s) are responsible for shared service agreements? Is this centralized? Do you understand all activities that use a third-party service provider? Could these meet the definition of a lease? Do we understand on which system(s) all of our lease data is maintained? Can we extract lease data from these systems? Do we maintain non-real estate lease information outside of core systems (e.g., Excel)? Section 9.2.2

Governance plan Project management
Structure, key stakeholders, process owners Timeline and milestones Change management framework and communications Understand the requirements of ASC 842 Internal training considerations Project work plans Resource considerations Concurrent initiatives System considerations Section 9.2.2

Why start to prepare for change now?
Companies with significant leasing activity will need time to evaluate their readiness for the new leases standard, gather necessary data, make judgments, develop estimates and implement necessary technology. Companies should understand the potential implications of the new leases standard to make informed decisions. Should the company modify existing lease arrangements or other agreements impacted by the new leases standard? How should the company approach key contractual areas such as lease term and renewal options as it negotiates new lease arrangements? Planning ahead may help to reduce the overall cost of implementation by allowing a company to make informed decisions and minimize unwanted surprises and costly missteps. Section 9.2.2

Lease diagnostic project What you should consider in your lease diagnostic
Lease arrangement identification and scoping Identifies the population of arrangements for evaluation under the new standard Classifies the population into the different types of lease arrangements Considers materiality of the type of leases in relation to the company’s financials Lease arrangement selection and review Selects lease arrangements for review that are representative of the types of lease arrangements identified Develops preliminary view of the accounting implications, as well as the methodology for forming judgments and estimates required under the new standard Assess current policies, controls, processes and systems Formalizes understanding of the current state accounting policies, processes, controls and systems for lease administration and lease accounting Develops preliminary view of which processes and controls would be leveraged or revised and system requirements of the future state Gap assessment Summarizes gaps in data, policies, processes, controls and systems that will need to be addressed as part of the design and implementation phases of the lease accounting change journey Section 9.2.2 Preliminary accounting policy selection Utilizes lease arrangements reviewed as part of the diagnostic to develop preliminary accounting policy selections to streamline evaluation of the remaining lease population Current state understanding

Appendix – Finance and operating lease accounting illustration
Section 9.2.2

New leases standard Appendix A – lessee accounting examples
Example 1 – finance lease* Lessee enters into a three-year lease of equipment and concludes that the agreement is a finance lease because the lease term is for a major part of the remaining economic life of the underlying asset (also three years). The arrangement provides the following: Lease term Three years Annual payments Year 1 – $10,000 Year 2 – $12,000 Year 3 – $14,000 Discount rate 4.235% Present value (PV) of lease payments $33,000 Section 9.2.2 * Refer to section in the Technical Line for more details on the fact pattern and calculations

Example 1 – finance lease Initial Year 1 Year 2 Year 3 Cash lease payments $10,000 $12,000 $14,000 Lease expense recognized: Interest expense $ 1,398 $ 1,033 $ 569 Amortization expense 11,000 Total periodic expense $12,398 $12,033 $11,569 Balance sheet: ROU asset $ 33,000 $ 22,000 $ 11,000 $  Lease liability $(33,000) $(24,398) $(13,431) Section 9.2.2

Example 1 – finance lease Debit Credit At lease commencement ROU asset $33,000 Lease liability To initially recognize the ROU asset and lease liability Year 1 journal entries Interest expense $1,398 To record interest expense and accrete the lease liability using the interest method ($33,000 x 4.235%) Amortization expense $11,000 To record amortization expense on the ROU asset ($33,000 ÷ 3 years) $10,000 Cash To record lease payment Section 9.2.2

Example 2 – operating lease* Lessee enters into a three-year lease of office space and concludes that the agreement is an operating lease. The arrangement provides the following: Lease term Three years Annual payments Year 1 – $10,000 Year 2 – $12,000 Year 3 – $14,000 Discount rate 4.235% Present value (PV) of lease payments $33,000 Section 9.2.2 * Refer to section in the Technical Line for more details on the fact pattern and calculations

Example 2 – operating lease Initial Year 1 Year 2 Year 3 Cash lease payments $10,000 $12,000 $14,000 Income statement: Periodic lease expense (straight-line) 12,000 Prepaid (accrued) rent for period $(2,000) $  $2,000 Balance sheet: Lease liability $ (33,000) $ (24,398) $ (13,431) ROU asset: $33,000 $24,398 $13,431 Adjust: Accrued rent (cumulative)  (2,000) ROU asset $22,398 $11,431 Section 9.2.2

Example 2 – operating lease Debit Credit At lease commencement ROU asset $33,000 Lease liability To initially recognize the ROU asset and lease liability Year 1 journal entries Lease expense $12,000 $2,000 Cash $10,000 $8,6021 $8,602 To record lease expense and adjust the ROU asset for the difference between cash paid and straight-line lease expense (i.e., accrued rent) and adjust the lease liability to the PV of the remaining lease payments with an offset to the ROU asset 1 The adjustment of $8,602 is calculated as the initially recognized lease liability ($33,000) less the present value of remaining lease payments ($24,398) at the end of Year 1 Section 9.2.2

Finance lease Operating lease Interest expense Amortization expense Total expense Periodic difference Year 1 $1,398 $11,000 $12,398 $12,000 $398 Year 2 1,033 11,000 12,033 12,000 33 Year 3 569 11,569 (431) $3,000 $33,000 $36,000 $  Lease liability ROU asset Both lease types Finance lease Operating lease Initial $33,000 Year 1 24,398 22,000 22,398 Year 2 13,431 11,000 11,431 Year 3  Section 9.2.2 Note: Refer to sections and in the Technical Line for more details on the fact pattern and calculations

Disclaimer These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice. The views expressed.

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Disclaimer These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice. The views expressed.

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