As ASC 842 compliance became effective for public companies, and private companies are now implementing compliance solutions in anticipation of the compliance deadline, accounting professionals are wrestling with many details – including borrowing rates.
Why fair market value is important
Determining the applicable incremental borrowing rate (IBR) can be a struggle. The IBR is the discount rate companies need for discounting cash flows and quantifying lease liabilities for the balance sheet. Ideally, the lessee should use the interest rate implicit in the lease, however, it is not always that straightforward. That approach also requires knowledge of the fair value of the leased asset.
What type of leases use fair market value
The fair market value purchase option (FMV) provides an option to buy a leased asset at the end of the lease term at a price that represents the current worth of the asset. It’s important to note, it is not an obligation to buy the asset. FMV is a popular and affordable option for assets that quickly become obsolete, such as laptop computers, GPS systems and other types of technology. It’s a smart way to manage costs and maintenance issues related to technology equipment that quickly becomes aged and outdated.
An alternative to a FMV lease
An alternative to FMV is a fixed-price purchase option. This option gives the lessee a specific cost of purchasing the asset at the end of the lease term, without knowing what the fair market value will be at the end of the lease. FMV and IBR are among the many lease accounting calculations which need to be executed correctly to make fully informed decisions about lease-versus-buy and lease structure and lease options selected. A company should develop a comprehensive, sustainable environment to fully monitor, control and continuously optimize leasing practices. Learn more about how you can meet the new lease accounting requirements and drive positive business results with CoStar lease accounting software.