For public companies, the calculation of the incremental borrowing rate has represented no small challenge. Fortunately, for most private companies and not-for-profit organizations, the FASB has issued a practical expedient to help ease the pain.
The guidance states that these entities are “permitted to use a risk-free discount rate for the lease, determined using a period comparable with that of the lease term, as an accounting policy election for all leases”. (ASC 842-20-30-3)
This is great news, but what exactly is the risk-free rate and how does it apply to your lease portfolio?
We’ve broken it out into 3 simple steps to ensure you get this right.
- Segment your lease portfolio into general buckets based on term and contract currency (e.g. 2, 5, 10 years, USD, CAD, GBP, EUR, AUS)
- Align the risk-free rates found here (https://www.bloomberg.com/markets/rates-bonds/government-bonds/us) with the terms and jurisdictions outlined above.
- Document (including screenshots of the rates) and discuss with your auditors as early as possible during the transition process to ensure alignment.
It’s important to note that this practical expedient must be applied to all leases in your portfolio, and it will likely result in a lease liability and ROU asset that is greater than if the incremental borrowing rates were calculated separately. Additionally, and it feels weird typing this, but the risk free rate cannot be less than zero.
You are going to want to get this completed and signed off by the auditors well in advance of transitioning onto the new standard. We’ve seen too many companies make the change post-transition, which requires unnecessary rework and journal entry reversals. In our experience auditors are happy to discuss this point well in advance of the audit.