Determining a leases discount rate
IFRS 16.26 sets out the discount rate requirement as follows:
“At the commencement date, a lessee shall measure the lease liability at the present value of the lease payments that are not paid at that date. The lease payments shall be discounted using the interest rate implicit in the lease, if that rate can be readily determined. If that rate cannot be readily determined, the lessee shall use the lessee’s incremental borrowing rate.”
Given a significant number of organisations are unlikely to have the necessary historical data to determine the interest rate implicit in the lease (“IRIIL”) for transition, it seems logical that the use of the incremental borrowing rate (“IBR”) will be relatively common at the date of adoption.
Additionally, any company choosing to use one of the modified retrospective approaches is required to use the IBR. For leases signed after transition, companies may be more readily able to determine IRIIL, however it is likely that companies will enter into leases which require the continued use of the IBR.
“The rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right of use asset in a similar economic environment.”
Additional detail on determining the incremental borrowing rate can be found in the guidance outlining the transition related practical expedient for using a single discount rate for a portfolio of leases:
“a lessee may apply a single discount rate to a portfolio of leases with reasonably similar characteristics (such as leases with a similar remaining lease term for a similar class of underlying asset in a similar economic environment).”
Combining these two aspects together results in the six factors (in green) requiring consideration in determining an IBR, either for an individual lease or a portfolio of leases.