Incremental Borrowing Rate under IFRS 16
IFRS 16 is the international accounting standard governing the accounting treatment of leases and has been applicable since January 1st, 2019. The Incremental Borrowing Rate (IBR) is used to discount a lessee’s lease liabilities. It consists of three components: the risk-free reference rate, the credit spread, and any lease-specific adjustments.
The IBR represents the rate of interest that the lessee would have to pay at the commencement date to borrow, over a similar term and with similar security, the funds necessary to obtain an asset of a value similar to the right-of-use asset in a comparable economic environment.
The Incremental Borrowing Rate has a greater impact on the measurement of a lease liability than any other input parameter and is often the area most closely scrutinized by auditors. We provide a structured report and help ensure that the underlying evidence and supporting documentation are clearly documented, robust, and fully traceable.
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Common Questions: Q&A
At the commencement date of the lease, the lease liability is measured at the present value of the lease payments that have not yet been made. For discounting purposes, IFRS 16.26 requires the lessee to use the interest rate implicit in the lease, provided that this rate can be readily determined. If this is not possible, the lessee shall use its Incremental Borrowing Rate (IBR).
No. As a general rule, lessees recognize a lease liability and a corresponding right-of-use asset for each lease. However, optional recognition exemptions are available for short-term leases with a lease term of no more than twelve months and for leases of low-value assets.
The Incremental Borrowing Rate is generally composed of the following three components:
- Risk-free reference rate (e.g., swap rates, government bond yields, etc.), taking into account the economic environment, contractual currency, and lease term.
- Credit spread, reflecting the creditworthiness of the lessee.
- Lease-specific adjustments, particularly with regard to collateralization, the value of the right-of-use asset, and the payment structure.
The information required for the calculation of an Incremental Borrowing Rate includes:
- Nature of the lease
- Countries for which the Incremental Borrowing Rates are to be applied
- Calculation date
- Lease terms
- Information on any lease-specific adjustments (e.g., subsidiary rating adjustment or real estate adjustment)
- Relevant company-specific financial metrics (e.g., revenue, EBIT, interest expense, etc.)
No. A bank’s base rate is a short-term reference or policy rate that does not incorporate a term structure or a credit risk component. It bears no relationship to the financing costs that would be incurred for a long-term borrowing arrangement, such as a ten-year loan. Consequently, using the base rate for long-term leases would result in an underestimation of the lease liability.
The use of a single discount rate for multiple leases is appropriate only if the leases are sufficiently similar in terms of lease term, collateralization, and commencement date. The rationale for the grouping should be properly documented and supportable. Leases with significantly different characteristics, such as a five-year vehicle lease and a thirty-year real estate lease, should not be discounted using the same rate.
If a company has no borrowing history of its own, the Incremental Borrowing Rate cannot be derived directly from observable financing transactions. In such cases, the rate must be estimated, for which the three-component approach is a suitable methodology. Under this approach, credit spreads observed on debt instruments issued by companies of comparable size and credit quality are used as a benchmark. For subsidiaries within a group, the borrowing rate of the parent company may also serve as a starting point, provided that it is appropriately adjusted to reflect the specific creditworthiness and financing characteristics of the respective entity.
Not routinely. The lease liability is not remeasured and discounted simply because market interest rates have changed. However, an updated discount rate must be used in certain circumstances, such as when the lease liability is remeasured due to a change in the lease term or as a result of a lease modification.
Further information can be obtained either directly from the IFRS 16 standard or from our Grant Thornton "Insights into IFRS 16".
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