FASB has proposed an update to ASC 842 that would affect non-public companies with leased assets.
ASC 842 currently provides non-public companies with a practical expedient to elect to use a risk-free rate as the discount rate instead of the higher incremental borrowing rate. But this practical expedient must be used for all leases. The proposed policy would allow non-public companies to make the risk-free rate election by class of underlying assets.
The advantage of using the risk-free rate practical expedient is that it eases the administrative burden of capturing an incremental borrowing rate for each lease. The disadvantage of using the risk-free rate is that there’s an inverse relationship between the interest rate and the net present value of lease payments. So as the interest rate goes down, the calculated lease liability goes up.
Non-public companies often don’t use the risk-free rate practical expedient for all their leases because the lower risk-free rate increases the balance sheet gross up associated with ASC 842 adoption. However, the proposed update would allow them to use a risk-free rate for certain classes of leased assets and an incremental borrowing rate for others.
For example, a non-public company with leased copiers and vehicles that compose the majority of a portfolio by number of assets could categorize those leases into one class. While the company’s leased real estate—which makes up the majority of the portfolio by net present value of lease payments—could be split into another. This would allow the company to use the risk-free rate for copiers and fleet vehicles to efficiently administer the large number of leases, and use the incremental borrowing rate for real estate, where the balance sheet impact is key due to the higher dollar amounts.
CoStar lease accounting software includes discount rate matching, so companies never have to worry about the administrative burden of capturing a high number of discount rates. Contact CoStar Real Estate Manager to learn more and see a demo of discount rate matching.
View the proposed FASB update here.