FASB issues risk-free rate rule to cut costs for nonpublic lessees

Private company, not-for-profit, and employee benefit plan lessees will be able to elect risk-free rates by class of underlying asset rather than at the entitywide level for lease accounting under a new standard issued Thursday for nonpublic entities by FASB.

The change is intended to reduce the cost of implementing FASB’s lease accounting standard while retaining the benefits of the standard for financial statement users.

Under FASB ASC Topic 842, Leases, lessees that are not public business entities are permitted to use a practical expedient that allows them to make an accounting policy election to use a risk-free rate as the discount rate for all leases.

FASB received feedback that some private companies were reluctant to use the risk-free rate election for all leases because a risk-free rate, such as a U.S. Treasury rate, is low compared with their expected average incremental borrowing rate. Therefore, using the risk-free rate election could increase an entity’s lease liabilities and right-of-use assets.

The amendments in Accounting Standards Update No. 2021-09, Leases (Topic 842): Discount Rates for Lessees That Are Not Public Business Entities, permit a risk-free rate election by class of underlying asset, rather than at the entitywide level.

If the rate implicit in the lease is readily determinable for any individual lease, the new standard requires a nonpublic business entity lessee to use that rate rather than a risk-free rate or an incremental borrowing rate. This is true regardless of whether the nonpublic business entity has made the risk-free rate election.

Entities that have not yet adopted Topic 842 as of Nov. 11, 2021, are required to adopt ASU 2021-09 at the same time that they adopt Topic 842.

For entities that have adopted Topic 842 as of Nov. 11, 2021, the amendments in ASU 2021-09 are effective for fiscal years beginning after Dec. 15, 2021, and interim periods within fiscal years beginning after Dec. 15, 2022. Earlier application is permitted.

— Ken Tysiac (Kenneth.Tysiac@aicpa-cima.com) is the JofA‘s editorial director.