Determination of incremental borrowing rates
IFRS 16-compliant accounting for leases
According to IFRS 16, usually incremental borrowing rates are needed to depict leases accurately from the lessee’s perspective. Future lease payments must be discounted, preferably using the interest rate implicit in the lease. However, this rate is typically not known to the lessee, as it could reveal the lessor’s margin. In such cases, the lessee must instead determine an incremental borrowing rate — i.e., 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. As this rate is also not directly observable, it must be assessed individually for each lease.
IFRS requirements
According to IFRS 16.26, companies are required to use the interest rate underlying the lease — usually represented by the incremental borrowing rate — to determine the lease liability accurately.
Validity of sources
Current capital market data and company-specific information are used to reliably estimate incremental borrowing rates.
Documentation
The data collection and processing is presented in a transparent and comprehensible manner through complete, clearly structured documentation.
Individually determined incremental borrowing rates
We determine incremental borrowing rates using a “build-up approach” derived from IFRS 16.A.
IFRS-compliant calculation
of incremental borrowing rates
According to IFRS 16.26, the incremental borrowing rate is to be used to discount expected lease payments unless the implicit interest rate underlying the lease is known. To determine the interest rate, a procedure derived from capital market theory is recommended. This “built-up approach”, which has been established in practice, explicitly takes into account the individual key criteria of “duration”, “collateralization”, “value” and “economic environment” mentioned in IFRS 16.A.
Reference interest rate
Bonds with a high credit rating from the same currency area are used to determine the incremental borrowing rate, as they reflect the economic environment. This requires a duration-congruent adjustment to ensure a maturity equivalence between the yield curves used, which are mostly based on zero-coupon bonds without ongoing payments, and the payment pattern of the leases. Accordingly, a reference rate of interest with an equivalent duration is selected.
Company-specific risk
The company-specific risk is derived from publicly traded unsecured corporate bonds of the same risk class. The company’s credit rating is used for this purpose. The interest rate used is the sum of the reference interest rate and a risk premium (credit spread). It is approximately determined by linear interpolation based on the bond price, coupon payments and the nominal value.
Asset risk
The credit risk premiums for company-specific risk are calculated on the basis of unsecured, top-tier corporate bonds. Leases, however, are generally fully secured by the underlying leased asset. In order to reflect the underlying asset’s specific risk, the risk premiums are adjusted to take account of the quality of the underlying leased asset’s collateralization. This reflects the lessor's ability to obtain liquidation proceeds from the sale of the asset in the event of a payment default.
Country risk
Country risk premiums are used when a reference interest rate does not adequately reflect another country’s economic risks . One accepted approach is the adjustment of the pricing another country’s highest credit rating bonds by of Country Risk Premiums (CRP).
What is an incremental borrowing rate?
IFRS 16 defines the incremental borrowing rate as 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.”
What does IFRS 16 cover?
What are the typical practical challenges when determining the incremental borrowing rate?
What are zero-coupon bonds (zero bonds)?
What is country risk premiums (CRP)?
.png)