Understanding the Relevant Borrowing Rate Under ASC 842
The Accounting Standards Codification (ASC) 842 provides guidelines for lease accounting in the United States.
One of the key components of ASC 842 is the determination of the lease liability and lease asset, which is based on the present value of lease payments using the relevant borrowing rate. In this blog, we will discuss the relevant borrowing rate under ASC 842 and its importance in lease accounting.
What is the Relevant Borrowing Rate?
The relevant borrowing rate is the rate of interest that a lessee would have to pay to borrow funds on a collateralized basis over a term equal to the lease term. The relevant borrowing rate reflects the creditworthiness of the lessee and the collateral pledged for the lease. It is an important component in calculating the present value of lease payments and determining the lease liability and lease asset.
Why is the Relevant Borrowing Rate Important?
The relevant borrowing rate is important in lease accounting because it affects the calculation of the lease liability and lease asset. The lease liability is the present value of lease payments, and the lease asset is the right to use the leased asset over the lease term. The lease liability and lease asset are recorded on the balance sheet and impact financial ratios and other financial metrics.
How is the Relevant Borrowing Rate Determined?
Under ASC 842, the relevant borrowing rate is the interest rate implicit in the lease, if that rate can be readily determined. If the interest rate implicit in the lease cannot be readily determined, the lessee must use its incremental borrowing rate.
The incremental borrowing rate is the rate of interest that the lessee would have to pay to borrow funds over a term equal to the lease term, secured by collateral similar to the leased asset, and with the same credit rating as the lessee. The lessee should use its incremental borrowing rate at the lease commencement date, not the date when the lease is initially recognized.
Conclusion
The relevant borrowing rate is an important component in lease accounting under ASC 842. It is used to calculate the present value of lease payments and determine the lease liability and lease asset. The relevant borrowing rate reflects the creditworthiness of the lessee and the collateral pledged for the lease. By understanding the relevant borrowing rate and its importance in lease accounting, businesses can ensure accurate financial reporting and compliance with ASC 842.
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