This presentation is part of the construction breakfast series. It gives an overview and basic concepts on leasing.

1. Construction Breakfast Series:
LEASING CHANGES WILL AFFECT YOUR OPERATIONS: ARE YOU
PREPARED?

2. Topics for today
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How will this impact the financials of my company?
How will banking and bonding relationships view this new
standard?
Discuss proactive strategies for your benefit.
This discussion will be from the Lessee side of the transaction
and will not cover Lessor accounting.

3. Overview & Basic Concepts of Topic 842 - Leasing

4. Overview of Topic 842
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Most leases, including what previously would be considered an operating
lease, will be recorded on the balance sheet.
New presentation and disclosure requirements in your financial statements.

5. Old vs New: what changes will I see?
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Under current GAAP, the majority of leases fall under two lease categories:
 Operating Lease – a lease whose term is short compared to the useful life of the
asset or piece of equipment being leased. ( example: Building lease, copier lease,
etc.)
 Capital Lease – a lease in which the lessor only finances the lease asset and all
other rights of ownership transfer to the lessee for accounting purposes. Capital
lease is determined based on meeting one of four criteria:
 Ownership – transfers at the end of the lease
 Bargain Purchase option – lessee can purchase asset at end of lease term for
below-market price
 Lease term – period of lease encompasses at least 75% of the useful life of the
asset
 Present value (PV) – present value of minimum lease payments is at least 90%
of fair value of asset at inception of lease

6. Old vs New: what changes will I see?
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Under Topic 842 the two main categories of leases will be:
 Operating Lease – Same approximate definition as old GAAP
 Finance Lease – very similar to the definition of capital lease under old GAAP,
subject to five criteria instead of four:
 Transfer of ownership to Lessee at end of lease term
 Purchase Option that is reasonably certain to be exercised by Lessee
 Lease term is for the major part of remaining economic life – guideline is 75%,
but a percentage is not stated in the standard
 Present Value – PV of minimum lease payments equals or exceeds substantially
all of the fair value of the underlying asset – guideline is 90%, no stated in
standard
 Underlying asset is of a specialized nature – this is new criteria.
Definition of leases under Old vs New have very similar definitions and criteria.

7. Lessee Accounting
B/S
• Right-of-use asset
• Lease liability – (non-debt)
I/S
• Lease expense
(Straight-line)
C/F
• Cash paid for
lease payments
• Rent expense (Straight-line)
• Cash paid for rent
• NONE
Operating Lease – OLD GAAP Operating Lease – NEW GAAP

8. Lessee Accounting
B/S
• Right-of-use asset
• Lease liability – (debt)
I/S
• Amortization exp
• Interest expense
C/F
• Cash paid for
principal & interest
• Depreciation exp
• Interest expense
• Cash paid for
principal & interest
• Capitalized asset
• Lease liability – (debt)
Capital Lease – OLD GAAP Finance Lease – NEW GAAP

9. Lessee Accounting – New GAAP Topic 842
B/S
• Right-of-use asset
• Lease liability
I/S
• Lease expense
(Straight-line)
C/F
• Cash paid for
lease payments
• Amortization exp
• Interest expense
• Cash paid for
principal & interest
• Right-of-use asset
• Lease liability
Finance Lease Operating Lease

10. An Example:
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Case Study – Finance or Operating Lease?
 Customer enters into a contract to lease a truck for four years
 Supplier will maintain the truck during the contract
 The Truck is kept at the Customer’s premise and is specified within the contract
 Consideration in the contract is $25,000 at the end of each of the 4 years for a total
of $100,000
 Customer may choose to buy the equipment at the end of the contract for fair
market value.

11. Question – Is this an operating or finance lease?
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Discuss the 5 criteria
 Truck does not transfer at the end of the lease.
 No bargain purchase option contained within the lease.
 No specialization on the truck.
 Economic life of the truck = 10 years
 Lease term = 40% (4 year lease / 10 year life)
 Fair value of the truck is $110,000
 Lease payment = 91% (100,000 lease payment / 110,000 fair value)
 Should factor in present value based on incremental borrowing rate, but simplified due to
time.
The lease payments make up over 90% of the fair value of the truck. Truck is
a financial lease!
How do we account for this?

12. Finance Lease
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Lease Commencement
Right-of-Use Asset 100,000 Lease liability
Lease Liability (100,000) Lease liability

13. Finance Lease
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End of Year 1
Amortization Expense 25,000 Initial Right-of-Use Asset of $100,000 / 4 year
term
Right-of-Use Asset (25,000)
Interest Expense 4,000 Beginning of period Lease Liability of $100,000
x discount rate of 4.00%
Lease Liability (4,000)
Lease Liability 25,000
Cash (25,000) Annual payment per lease agreement

14. Operating Lease
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Lease Commencement
Right-of-Use Asset 100,000 Lease liability
Lease Liability (100,000) Lease liability

15. Operating Lease
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End of Year 1
Lease Expense 25,000 Total lease payments $100,000 / total lease
term of 4 years
Right-of-Use Asset (21,000)
Lease Liability (4,000) Beginning of period Lease Liability of $100,000
x discount rate of 4.00%
Lease Liability 25,000
Cash (25,000) Annual payment per lease agreement

16. Related Party Leases
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Topic 842 applies to all related party leases.
Use legally enforceable terms and conditions within lease to help classify
Month-to-month lease exception example
 Related party lease for building on a month-to-month term
 Renewal is expected to occur in a period greater than 12 months
 Related party entity that leases the building relies on lease payments to fund
existing mortgage.
 You will need to record a right-of-use asset and lease liability as if this were an
operating/finance lease.
 Judgement will be used to determine expected lease term.

17. How could this leasing standard impact your banking and bonding?
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Banking
 Operating vs Finance classification could have impact on your debt covenants.
 Debt service coverage ratio – finance lease would be considered part of your
debt.
 Current/working capital ratio and others will now be impacted negatively by
operating leases.
 If you have significant leasing, make sure you are discussing this new standard
with your bank.
Bonding
 Your current/working capital ratio will be impacted negatively.
 Make sure you are having discussions with your bonding company on how these
standards will impact their calculations.

18. Proactive strategies
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Discussions with banking and bonding relationships before these rules go into
effect are paramount. Do NOT get caught off-guard with these changes
impacting your borrowing capability or bonding capacity.
EBITDA effect
 Companies that utilize EBITDA as an important multiple for performance metrics
and/or debt covenants are benefited by a Finance Lease setup which gives
Amortization as an add-back to EBITDA.

19. Key Points
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Changes to your balance sheet and negative impact to certain ratios
Related party leases and what to look for
Lessee expense recognition (Amortization vs Lease expense)
More robust disclosures
Effective date (for calendar year entities with quarterly statements)
 Public companies = March 31, 2019
 All other companies = December 31, 2020
 Earlier adoption is permitted

20. Next Steps
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Examine the current processes and controls in place to gather information
Evaluate the expected impact
Prepare for implementation
We are here to answer any and all questions you
may have as you start to look at this. Don’t hesitate
to reach out and ask us!

21. Questions?