On September 15, 2021, the Financial Accounting Standards Board (FASB) proposed an update to ASC 842 which would allow private companies and nonprofit organizations to use different discount rates for leases. This would be a significant update that will result in companies saving money.

This proposed update made by the FASB makes it easier to comply with the new lease accounting standard.

Previous Discount Rate Guidance for ASC 842

Under the new lease accounting standard, at the lease commencement date, lessees were to determine the present value of the lease payments to calculate the ROU asset and lease liability using the rate implicit in the lease. 

Since the rate implicit in the lease is often not easily obtainable, the lessee can use the collateralized borrowing rate, which is the rate at which the lessee would borrow money to purchase the same asset with a similar loan term. 

Nonpublic companies have the added flexibility for discount rates by electing to use the risk-free rate as of the lease commencement date for a similar time period, which would be significantly easier to determine. However, if a nonpublic company made this election, the risk-free rate had to be applied to all its leases. This would leave the organization to balance the attractiveness of using an easier calculation against booking a higher lease liability.

Proposed Changes to Discount Rate Determination

Recognizing the need for additional flexibility on determining the discount rate, the FASB proposes allowing a nonpublic company to elect using the risk-free rate by asset class. While this election and the asset classes to which it applies must be disclosed, this is an important and positive proposal.

What does this Mean for You and Your Clients?

Organizations can now take the extra time to calculate what is likely a higher collateralized borrowing rate for their largest dollar-value leases, such as office space. For lower-value assets, like vehicles or small equipment, the impact of using the more easy-to-determine risk-free rate is twofold: it saves time and the impact to the lease liability is likely far less material.

Bottom Line

If you have any questions about the proposed changes to discount rate determination, contact us to speak with one of our lease accounting experts today.