Lease Accounting Update – Discount Rate

Under ASC 842, lessees are required to use the rate implicit in the lease as the discount rate. The rate implicit in the lease is the interest rate the lessor is charging the lessee. It is referred to as the implicit rate because it is not usually specified, or explicit, in the lease agreement and must be inferred by the lessee based on additional information. When the implicit rate is not readily available, private companies are allowed to make an election to use a risk-free rate (rather than the incremental borrowing rate) as the discount rate for measuring the lease liability and the right-of-use asset. Currently, the standard requires this election to be made at the entity-wide level for the entire lease portfolio (and all leases within it).

The Financial Accounting Standards Board ("FASB") proposed an accounting standard update ("ASU") regarding this election for nonpublic business entities.  The proposal would permit lessees to elect to use a risk-free rate as the discount rate for leases by class of underlying asset, rather than at the entity-wide level.

The proposal also would require that when the rate implicit in any lease is readily determinable for any individual lease, a lessee would use that rate (rather than a risk-free rate or an incremental borrowing rate) regardless of whether it has made the risk-free rate election.

Generally speaking, using risk-free rate would mean less discount and therefore large ROU asset and lease liability.

For details, please see the proposed ASU below:

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