The Financial Accounting Standards Board released a proposed accounting standards update Wednesday with the goal of improving the discount rate guidance for lessees that are not public businesses, such as private companies, not-for-profits and employee benefit plans.
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However, some private companies have told FASB they’re reluctant to use the risk-free rate election for all their leases. They pointed out that in the current economic environment, a risk-free rate (such as a U.S. Treasury rate) is low compared with their expected average incremental borrowing rates, and that using the risk-free rate election could increase an entity’s lease liabilities and right-of-use assets.
To deal with such concerns, the amendments in the proposed update would permit lessees that are not public business entities to make the risk-free rate election by class of underlying asset, instead of at the entity-wide level. The guidance would also require that when the rate implicit in the lease is readily determinable for any individual lease, a lessee would use that rate (instead of a risk-free rate or an incremental borrowing rate), regardless of whether it has made the risk-free rate election.
The leasing standard would put operating leases on the balance sheet of most companies for the first time. Many private companies have been slow to adopt the leases standard after seeing the difficulties that public companies faced when they were required to adopt the new standard in 2019. Last year, in response to the pandemic, FASB delayed the effective date of the leases standard for private companies and nonprofits until the end of the year, but the date is fast approaching (
The proposed update on discount rates gives private companies additional flexibility. “While ASC 842 already provided an optional practical expedient for private companies (not available to public companies) by allowing them to utilize a risk-free rate (RFR) as the discount rate for the entire lease portfolio, private entities requested that the RFR election be applied at the asset class level,” said Melissa Sacks, director at LeaseQuery, a lease accounting software company. “The FASB responded by issuing this exposure draft which does just that: [It] allows private companies to strategically apply discount rate guidance by making the RFR election at the asset class level, instead of requiring them to utilize it entity-wide.”
She noted that discount rates are a vital part of ASC 842 because they directly affect the lease liability recorded on the balance sheet. “Prior to ASC 842, all operating leases were off balance sheet,” said Sacks. “ASC 842 brings the majority of leases onto the balance sheet by requiring lessees to record a lease liability and related right-of-use asset for both operating and finance leases. Public companies (and those private entities who don’t take advantage of this practical expedient) are required to use the incremental borrowing rate (IBR) as the lessee's discount rate. Incremental borrowing rates are much more complex and determination of the IBR is not straightforward. So, essentially, what this proposal does is ease the transition to ASC 842 for private companies by expanding the application of the RFR.”
If private entities choose to apply the RFR practical expedient by asset class, it must be an accounting policy election and consistently applied across the company's lease portfolio, she noted. “These companies would also be required to disclose which asset classes utilized the RFR as the discount rate and which utilized the incremental borrowing rate as the discount rate,” said Sacks. “This proposal impacts all private entities, both those who have early adopted the new guidance and those who have not yet transitioned to ASC 842.”
FASB is asking for comments on the