Private companies and nonprofits have leeway to choose the discount rate they use in calculating the value of their operating leases under new lease accounting standards, the Financial Accounting Standards Board (FASB) decided this week.
The decision is intended to make it easier for organizations to comply with the new standards, known as ASC 842, which take effect at the end of this year. ASC 842, which requires organizations to recognize operating leases on the balance sheet in the same way as capital leases, rather than in the footnotes to their financials as operating expenses, is already in effect for public companies.
This week’s change permits organizations to choose between a discount rate such as the incremental borrowing rate and a risk-free rate such as Treasury bills for certain types of leases. Prior to the change, organizations had to choose one type of rate and apply it to all of their leases. Now they can choose one rate for one class of leases and another rate for another class.
The new flexibility is expected to lower compliance costs, since computing present value using something like the incremental borrowing rate, although it can be highly accurate, requires a complex and costly calculation that is probably unnecessary for non-material leases. The risk-free rate, by contrast, is simple to use, but because it tends to be lower than what’s produced by more complex calculations, can increase lease liabilities.
Given these differences, organizations might choose a more complex calculation for high-value leases, such as those for commercial property, and a risk-free rate for lower-value leases like those tied to office equipment.
“I might have something like a whole group of immaterial computer equipment individually that I’m leasing and then I might have a material piece of computer equipment,” said FASB Vice Chair James Kroeker. “I think if you look at asset class, it may well be you can designate these as different asset classes, so I think it does provide you, if not flexibility at the individual lease level, [then] in what asset class you do or don’t have.”
The new lease standards take effect December 15. The option to use different discount rate calculations for different asset classes doesn’t apply to public companies, which are assumed to have the resources to use the more accurate calculations for all of their leases.
