Discount rates under ASC 842, including the risk-free rate election

Few leases state their rate, so most lessees build an incremental borrowing rate, and US private companies can choose a risk-free rate instead. This guide explains the options, how to build a collateralized rate, and what the risk-free rate election does to the numbers.

By Mirza Fahad Baig, Chartered Accountant. Reviewed by Hamza Fida, Chartered Accountant. Checked against official sources on . 3 minute read.

Short answer

The ASC 842 discount rate is the rate implicit in the lease if the lessee can readily determine it. Otherwise it is the lessee's incremental borrowing rate: the rate it would pay to borrow, on a collateralized basis over a similar term, an amount equal to the lease payments in a similar economic environment. Private companies, meaning entities that are not public business entities, may instead elect a risk-free rate, by class of underlying asset.

At a glance

First choice
Rate implicit in the lease
Usual choice
Incremental borrowing rate
Basis
Collateralized, similar term
Private companies
May elect a risk-free rate
Election
By class of underlying asset
Excel
Lease calculator
Discount rates under ASC 842, including the risk-free rate electionFirst choice: Rate implicit in the lease; Usual choice: Incremental borrowing rate; Basis: Collateralized, similar term; Private companies: May elect a risk-free rate; Election: By class of underlying asset; Excel: Lease calculator.KEY FACTS AT A GLANCEDiscount rates under ASC 842, including therisk-free rate electionFirst choiceRate implicit in theleaseUsual choiceIncremental borrowingrateBasisCollateralized, similartermPrivate companiesMay elect a risk-freerateElectionBy class of underlyingassetExcelLease calculatorChecked against official sourcesTax BakersDiscount rates under ASC 842, including the risk-free rate electionFirst choice: Rate implicit in the lease; Usual choice: Incremental borrowing rate; Basis: Collateralized, similar term; Private companies: May elect a risk-free rate; Election: By class of underlying asset; Excel: Lease calculator.KEY FACTS AT A GLANCEDiscount rates under ASC 842,including the risk-free rateelectionFirst choiceRate implicit in the leaseUsual choiceIncremental borrowing rateBasisCollateralized, similar termPrivate companiesMay elect a risk-free rateElectionBy class of underlying assetExcelLease calculatorChecked against official sourcesTax Bakers
Key facts at a glance, as set out in this guide.

Which ASC 842 discount rate should a lessee use?

The rate implicit in the lease if it is readily determinable, which is uncommon because lessees rarely know the lessor's residual value assumptions and initial direct costs. Otherwise the incremental borrowing rate. Private companies have a third option, a risk-free rate, explained below.

How is a collateralized incremental borrowing rate built?

Building a collateralized incremental borrowing rateBuilding a collateralized incremental borrowing rate3.75%Treasuryrate+2.25%Creditspread-1.00%Collateraladjustment5.00%Discountrate
From a Treasury rate to the rate used to discount the lease payments.

The incremental borrowing rate under ASC 842 is explicitly a collateralized rate, so it is usually below the lessee's unsecured borrowing cost. A typical build starts from a Treasury or swap rate for the lease term, adds the lessee's credit spread from its own borrowing or comparable companies, and deducts an adjustment for the security a lender would have in the leased asset. Some companies use a portfolio approach, applying one rate to leases with similar terms.

What is the private company risk-free rate election?

A lessee that is not a public business entity may use a risk-free rate, typically the US Treasury rate for a term similar to the lease, instead of its incremental borrowing rate. Since an amendment in 2021, the election can be made by class of underlying asset rather than for all leases. If the rate implicit in the lease is readily determinable, the lessee must use that rate instead.

A risk-free rate is lower than an incremental borrowing rate, so it produces a larger lease liability and right-of-use asset:

Discount rateLiability for five payments of $100,000
Risk-free rate, 3.75%$448,326
Incremental borrowing rate, 5.00%$432,948

The trade-off is simplicity against a higher balance sheet gross-up. Test both in the Lease calculator (Excel).

A worked example of the incremental borrowing rate

A US manufacturer leases a warehouse for five years. Five-year Treasuries yield 3.75%. Its unsecured five-year borrowing would cost about 2.25 points more. A lender would accept a lower spread with security over the warehouse lease, so it deducts 1.00 point, giving a collateralized incremental borrowing rate of 5.00%. It documents each input, its source and the date.

What do auditors look for in an ASC 842 discount rate?

A documented method showing each input, its source and date, and how the rate reflects the lease term, the currency and the collateralized basis. They test whether rates for new leases are refreshed as market rates move, whether a subsidiary's rate reflects its own credit or parent support, and whether a risk-free rate election has been applied consistently to every lease in the elected class. The weighted-average discount rate is also a required disclosure.

When does the discount rate change?

The rate is updated when the lease liability is remeasured for a change in the lease term or the assessment of a purchase option, or for a modification that is not a separate contract. It is not updated for changes in variable payments based on an index, or simply because market rates move.

How does this differ from IFRS 16?

IFRS 16 has no risk-free rate election, and its incremental borrowing rate is not defined as collateralized, although lessees consider the security of the leased asset. See the IFRS 16 discount rate, and for the entries that follow, ASC 842 journal entries.

Need help applying the standards?

Our Chartered Accountants help finance teams and students apply US GAAP and IFRS to real transactions.

Book a call Chat on WhatsApp

Questions people ask

What discount rate does ASC 842 require?

The rate implicit in the lease if readily determinable; otherwise the lessee's incremental borrowing rate. Private companies may elect a risk-free rate.

What is the incremental borrowing rate under ASC 842?

The rate the lessee would pay to borrow, on a collateralized basis over a similar term, an amount equal to the lease payments in a similar economic environment.

Who can use the risk-free rate under ASC 842?

Entities that are not public business entities, by class of underlying asset, unless the rate implicit in the lease is readily determinable.

Does the risk-free rate increase the lease liability?

Yes. A lower discount rate gives a larger present value, so the liability and right-of-use asset are larger.

Sources

Every fee, date and rule on this page was taken from these official and primary sources.

  1. FASB Accounting Standards Codification: Topic 842, Leases
  2. Financial Accounting Standards Board: Leases

Rules and fees change. If you are reading this long after October 4, 2026, confirm the figures with the source before you rely on them.

ASC 842ASC 842 lessee journal entries with examplesIFRS 16The IFRS 16 discount rate: incremental borrowing rateASC 842ASC 842 leases explained

More in ASC 842

Next in this topicLessor accounting under ASC 842TopicAll 5 guides in ASC 842

This guide is general information. It is not tax or legal advice for your situation.