In most situations, the new lease accounting guidance requires recognition by a lessee of a right-of-use asset and a lease liability on its balance sheet. The lease liability is measured as the present value of remaining lease payments. In general, each lease will require its own discount rate unless the lessee has elected to apply a portfolio approach. The discount rate determination is outlined under a specific framework, but it still requires critical judgments and a thorough review process.
Concluding upon a discount rate based on a lender’s quote or an existing borrowing facility is typically not appropriate. These items should be considered as data points only. The lender quote and rate on existing borrowing facilities on a stand-alone basis typically does not meet all of the criteria for a discount rate.
Our white paper “ASC 842: Calculating the incremental borrowing rate as a lessee” presents the requirements for developing the discount rate according to the new lease accounting guidance, and focuses on how an organization can determine the incremental borrowing rate for lessees.
The following topics are addressed in the white paper:
- What is the right discount rate?
- What is the incremental borrowing rate (IBR)?
- Components of the IBR, including:
- Lessee-specific credit risk
- Amount of the lease payments
- Collateralized nature of the IBR
- Quality of the lessee’s collateral
- Alignment of the borrowing term and the lease term
- Economic environment of the lease and foreign-currency considerations
- Reassessment of the discount rate—lessee
Determining the IBR involves components that meet the requirements of the guidance, and they need to be diligently documented, derived and explained. As a result, rate quotes from banks and revolving lines of credit (only applicable for one time length) are points to consider in the IBR but will be difficult to solely rely upon as the discount rates to apply to leases.