Understanding and Overcoming
Incremental Borrowing Rate Challenges

ASC 842 and IFRS 16 require the use of the discount rate implicit in the lease when present valuing the liabilities. If the rate cannot be determined, the incremental borrowing rate (IBR) should be used. Most leases do not have an implicit rate, so the IBR will be used to present value those obligations. However, there is significant confusion around how to calculate the IBR as the definition has changed somewhat under ASC 842. Companies also need to consider how to handle the IBR at different locations around the world.

Calculating the IBR:

Under ASC 842, the IBR should be fully collateralized. For companies that have multiple securitized debt agreements, calculating the IBR will be more straightforward. They can take the data points from their securitized debt agreements and interpolate what the rate should be for the lease depending on the asset and lease term.

However, many companies have limited examples of securitized debt, if any, to draw data from. For these companies, the calculation will be more difficult. Treasury will likely be a major source of information for determining the IBR and may need to take the lead on gathering useful data points. For example, Treasury may utilize the rate for unsecured debt, contact ratings agencies to determine how they calculate the present value of lease obligations, and ask peers in the marketplace that issued securitized debt. Pulling all of those numbers together could provide the base for calculating the final IBRs to be used for leased assets.

Regional Considerations:

One of the decisions companies will need to make regarding their IBRs is what rate to use for leases in different regions around the globe. Multi-nationals may hold leases in multiple countries under different currencies, complicating the calculation even further. However, corporations with a centralized treasury function may be able to argue for the use of one IBR globally if they can show that global operations would be funded with the central currency. Alternatively, even companies that cannot make this argument may be able to use one IBR per currency, rather than per country or region. However, these discussions will need to be held with external auditors to get their perspective on what is appropriate regarding the IBR.

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