Determining a leases discount rate

Determining a leases discount rate

The definition of the lessee’s incremental borrowing rate states that the rate should represent what the lessee ‘would have to pay to borrow over a similar term and with similar security, the funds necessary to obtain an asset of similar value to the right-of-use asset in a similar economic environment.’ In applying the concept of ‘similar security’, a lessee uses the right-of-use asset granted by the lease and not the fair value of the underlying asset.

This is because the rate should represent the amount that would be charged to acquire an asset of similar value for a similar period. For example, in determining the incremental borrowing rate on a 5 year lease of a property, the security for the portion of the asset being leased (i.e. the 5 year portion of its useful life) would be likely to vary significantly from the outright ownership of the property, as outright ownership would confer rights over a period of time that would typically be significantly greater than the 5-year right-of-use asset contained in the lease.

In practice, judgement may be needed to estimate an incremental borrowing rate in the context of a right-of-use asset, especially when the value of the underlying asset differs significantly from the value of the right-of-use asset.

An entity’s weighted-average cost of capital (‘WACC’) is not appropriate to use as a proxy for the incremental borrowing rate because it is not representative of the rate an entity would pay on borrowings. WACC incorporates the cost of equity-based capital, which is unsecured and ranks behind other creditors and will therefore be a higher rate than that paid on borrowings.

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IFRS 17 Full retrospective approach

IFRS 17 Full retrospective approach – When insurers apply IFRS 17 for the first time, the transition provisions of IFRS 17 require full retrospective application. However, a modified retrospective approach or a fair value method are allowed under circumstances where the full retrospective approach is impracticable.

Applying the full retrospective approach for IFRS 17 means that the contractual service margin (CSM) at the date of transition to IFRS 17 will be based on an assessment of the CSM (unearned profits) for each group of contracts at inception of the group and a roll-forward of those amounts to the transition date. The CSM at transition will be an important aspect of the capital impact on transition and on future accounting … Read more


It is impracticable to apply a requirement if the entity cannot apply it after making every reasonable effort to do so. ‘Impracticable’ is a high hurdle.

IFRS 17 Fair value approach Insurances

Elect to use the fair value approach if the full retrospective approach is impracticable, and it should if the modified retrospective approach is impracticable.