IFRS 16: The D word

Yup, you guessed what it is: discount rate.

At this stage, it has become clear that determining the discount rate to measure the net investment in the lease will be no easy feat. But before you throw your hands up in exasperation, let's explore how you can navigate this challenging route.

The implicit interest rate

Although the implicit interest rate is not in itself a new concept, it still presents a challenge—namely, how to apply it in the new world of lease accounting. As a reminder, the standard defines the interest rate implicit in the lease as the discount rate at which the sum of the present value of (i) the lease payments and (ii) the unguaranteed residual value equals the sum of (iii) the fair value of the underlying asset and (iv) any initial direct costs (of the lessor).

If this implicit interest rate can be readily determined, then the lessee should discount the lease payments using it. If it can't, then the lessee should use the incremental borrowing rate, which is specific to:

the lessee, specifically his/her company the terms of the arrangement, which is typically the lease duration unless the lease payments are paid up front the amount of the funding that is "borrowed" the "security" granted to the lessor, i.e. the nature and quality of the underlying asset the economic environment, or the jurisdiction and the time at which the lease is entered into as well as the currency in which the lease payments are denominated Despite this guidance, figuring out the incremental borrowing rate is still much harder than it seems.

So many questions, so little time

The burning question on everyone's lips: do I need to determine a discount rate for every lease? The answer is yes...