The Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) that improves discount rate guidance for lessees that are not public business entities—including private companies, not-for-profit organizations and employee benefit plans. The amendments in the ASU should reduce the cost of implementing the lease standard (Topic 842) for those entities while retaining the expected benefits for users of financial statements.

Topic 842 currently provides lessees that are not public business entities with 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. The FASB originally provided this practical expedient to relieve those lessees from the cost and complexity of having to calculate an incremental borrowing rate.

Some private company stakeholders expressed reluctance to use the risk-free rate election for all leases. Those stakeholders noted that a risk-free rate (for example, a U.S. Treasury rate) is low compared with their expected average incremental borrowing rates, and that using the risk-free rate election could increase an entity’s lease liabilities and right-of-use assets.

To address these concerns, the amendments in the ASU allow lessees that are not public business entities to make the risk-free rate election by class of underlying asset, rather than at the entity-wide level. It also requires that, when the rate implicit in the lease is readily determinable for any individual lease, a lessee use that rate (rather than a risk-free rate or an incremental borrowing rate), regardless of whether it has made the risk-free rate election.