Why This Matters
The discount rate converts future lease payments into their present value. Under ASC 842, selection of the appropriate rate may require significant professional judgment and affects both the classification analysis and the measurement of the lease liability.
1. Rate Implicit in the Lease
- Use if readily determinable from the lease terms
- Often not available to the lessee in practice
- Reflects the lessor's pricing assumptions
2. Incremental Borrowing Rate (IBR) — Most Common
- Rate the lessee would pay to borrow on a collateralized basis
- Should reflect a similar term to the lease
- Should reflect the lessee's current credit profile and economic environment
- Most frequently used in practice when the implicit rate is unavailable
3. Risk-Free Rate
- Available only to private companies under an applicable accounting policy election
- Generally results in a higher lease liability because the rate is lower
- Must be applied consistently to all leases if elected
Auditor Considerations
- Has management documented the basis for the selected rate?
- Does the term used for the rate match the lease term in the calculation?
- Is the selected rate reasonable for the entity and economic circumstances?
- If IBR was used, is it appropriately adjusted for collateralization and term?
This tool provides guidance only. Determining the appropriate discount rate requires professional judgment and should be documented in the engagement workpapers.