The Financial Accounting Standards Board (FASB) has proposed changes to the discount rate used to calculate right-of-use (ROU) assets and liabilities of a lease. The proposed amendment would give non-public entities the option to apply the risk-free rate as the discount rate by class of underlying asset rather than applying it on an entity-wide level. Currently, the risk-free rate election can be applied on an entity-wide level as a more cost-effective method of applying ASC 842 to leases where the implicit rate was not readily determinable and calculation of the company’s incremental borrowing rate would result in increased implementation cost. However, FASB noted that, “some lessees that are not public business entities may want to use their incremental borrowing rates to calculate lease liabilities for material asset classes (such as real estate) but prefer the simpler and less costly option of using a risk-free rate for asset classes that have lower values or greater volumes of leases (such as office equipment).” The proposed modification to ASC 842 would address this concern; however, if the implicit rate on the lease is readily determinable, the risk-free rate is not to be used even if the risk-free rate election has been made.
Overall, more flexibility in the application of ASC 842 will provide information that more accurately reflects the amount of interest and amortization for the period presented in a cost-effective manner. Non-public entities that elect to use the risk-free discount rate will be required to disclose this fact and state to which asset classes this election has been applied. The proposed update would be effective for fiscal years beginning after December 15, 2021, or upon adoption of ASC 842.