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Lease classification

Portfolio discount rate

Lessees and lessors may apply a single discount rate to a portfolio of leases if they can conclude that its
application does not create a material difference when compared to individually determined discount
rates applied to each of the leases in the portfolio. While a reporting entity is not required to
quantitatively demonstrate immateriality, it should be able to demonstrate that the leases in the
portfolio have similar characteristics, such that it is reasonable to expect that the application of the
portfolio-level discount rate will not materially differ from the application of discrete discount rates at
the individual lease level. When assessing materiality, reporting entities should also consider whether
a small change in the discount rate could result in different lease classification, such as when the lease
payments are close to substantially all of the fair value of the underlying assets. Example 3-17
demonstrates this concept.

EXAMPLE 3-17

Discount rate – portfolio discount rate

Lessee Corp enters into 20 separate leases with Lessor Corp for a fleet of similar vehicles; each vehicle
is of similar make and model, although certain features may vary (e.g., interior, radio, electronics).
Each lease has a term of three years. Depending on the vehicle’s particular features, annual fixed lease
payments range from $3,750 to $4,000. There are no purchase options or renewal options.

Can Lessee Corp and Lessor Corp apply a single discount rate to the portfolio of leases?

Analysis

Assuming the underlying assets are similar, have similar lease terms, the value and range of lease
payments do not vary greatly, interest rates have remained stable throughout the evaluation period,
and that the lease payments do not approach substantially all of the fair value of the underlying assets,
it is reasonable to conclude that the application of a single portfolio-level discount rate would not
create a material difference in classification when compared to applying individually determined
discount rates to each of the leases in the portfolio.

Private company considerations

ASC 842-20-30-3 provides a practical expedient for nonpublic business entities, which allows a lessee
to use a risk-free rate for a period comparable to the lease term. Since a risk-free rate is lower than an
incremental borrowing rate for a specific entity, it will result in a higher lease liability and right-of-use
asset. Use of a risk-free rate is an accounting policy election, and once elected must be utilized
consistently for all leases.

3.3.4.7 Collectibility (lessors)

Lessors are required to evaluate whether lease payments, and any amount necessary to satisfy a
residual value guarantee, are probable of collection, as discussed in ASC 842-30-25-3 for sales-type
leases. A sales-type lease is similar to a sale of the underlying asset. As such, when there is significant
concern regarding the collectibility of payments due under the terms of the contract, sale treatment
may be delayed.

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