7.3 Determination of the Discount Rate for Lessors
ASC 842-10
25-4 A lessor shall assess the criteria in paragraphs 842-10-25-2(d) and 842-10-25-3(b)(1) using the rate implicit in the lease. For purposes of assessing the criterion in paragraph 842-10-25-2(d), a lessor shall assume that no initial direct costs will be deferred if, at the commencement date, the fair value of the underlying asset is different from its carrying amount.
7.3.1 Initial Determination of the Discount Rate
A lessor should use the rate implicit in the lease (i.e., the rate it charges
the lessee) when evaluating lease classification and measuring its net
investment in a lease, if applicable. (See Section 7.1.1 for the definition of the
rate implicit in the lease.) Importantly, however, a lessor’s consideration of
initial direct costs in its calculation of the rate implicit in the lease will
be different depending on whether the rate is being used to determine lease
classification or when the lease is initially measured. As a result, a lessor
may determine different rates implicit in a lease depending on whether the rate
will be used to initially classify a lease or to initially recognize and measure
the lease. See Section 9.2.1.4.1 for more
information on how a lessor should consider initial direct costs when
calculating the rate implicit in the lease.
As discussed in Section
9.3.7.1, it is possible for the lessor to have a sales-type or
direct financing lease when the lease payments are entirely or significantly
variable. In such situations, the calculation of the rate implicit in the lease
may result in a negative discount rate. However, at its November 30, 2016, Board
meeting, and as codified in ASU 2018-10, the FASB clarified that it would be
inappropriate to use a negative discount rate. Therefore, lessors would use a 0
percent discount rate to measure the net investment in the lease. See Section 9.3.7.1.2 for a detailed discussion of
lessor accounting in these situations (e.g., the possibility of a
commencement-date loss when a sales-type or direct financing lease includes
significant variable payments).2
7.3.2 Reassessment of the Discount Rate
A lessor would only reassess the discount rate used for determining lease
classification when a lease is modified and the modification is not accounted
for as a separate contract or when an option is exercised that was originally
determined to be not reasonably certain (including both lessee options to extend
the lease term or purchase the underlying asset and lessor options to terminate
the lease). This would occur, for example, when there is a change in the terms
or conditions of the contract that affects the overall scope of or consideration
received as part of the contract. The discount rate to be used depends on the
classification of the lease before and after the lease modification. See
Section 9.3.4
for additional discussion of lessor lease modifications.
Footnotes
2
In July 2018, the FASB issued ASU 2018-10,
which makes Codification improvements to ASC 842 and amends the ASC
master glossary’s definition of the term “rate implicit in the lease” to
clarify that, under ASC 842, this rate cannot be less than zero.
Therefore, the rate implicit in the lease would default to zero if it is
calculated as less than zero. See Section 17.3.1.3 for further
discussion of the ASU. In addition, in July 2021, the FASB issued
ASU
2021-05, which amends ASC 842 to require lessors to
classify certain leases with variable lease payments that result in a
day 1 loss as an operating lease; accordingly, the uneconomic outcome of
a day 1 loss would generally be eliminated. See Section 17.3.1.8
for further discussion of the ASU.