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FASB Issues Improved Discount Rate Guidance for Private Company Lessees Under ASC 842

FASB Issues Improved Discount Rate Guidance for Private Company Lessees Under ASC 842

On November 11, 2021 the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) No. 2021-09, Leases (Topic 842): Discount Rate for Lessees That Are Not Public Business Entities. Prior to the issuance of this ASU, under ASC 842 private company entities could elect to use the risk-free rate as a practical expedient, allowing lessees to make an accounting policy election to use the risk-free rate as the discount rate for all leases. This practical expedient was meant to ease the burden of adopting ASC 842 by allowing private companies to utilize the risk-free rate, instead of incurring the time and cost of trying to ascertain an incremental borrowing rate when an implicit rate is not readily available. The downside with electing this policy was that the risk-free rate had to be applied to all leases. This caused concern with certain private company stakeholders, since the risk-free rate is low compared to a typical incremental borrowing rate, resulting in higher lease liabilities and right-of-use assets when adopting ASC 842.

ASU 2021-09 allows private companies to elect the risk-free rate practical expedient by class of underlying asset - instead of all leases. This provides flexibility to private companies with various types of leases such as buildings, vehicles, or equipment. Private companies may elect to use the risk-free for certain underlying asset classes, but also use an incremental borrowing rate for other underlying asset classes where it is deemed appropriate. ASU 2021-09 does require private companies to use the rate implicit in the lease when it is known or readily available for any individual lease regardless of its underlying asset class and regardless of whether the risk-free rate practical expedient has been elected.

As of November 11, 2021, for private companies that have not yet adopted ASC 842, ASU 2021-09 should be applied to all new and existing leases when first applying ASC 842, which for private companies is required for fiscal years beginning on or after December 15, 2021. For any private company early adopters that have adopted ASC 842 on or before November 11, 2021, ASU 2021-09 may be applied to financial statements issued for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. Earlier application is permitted as of the beginning of the fiscal year of adoption.

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