Estimating Interest Rate for Leases – IFRS 16 Requirement (2025 Edition)

Estimating Interest Rate for Leases – IFRS 16 Requirement (2025 Edition) Description

Estimating Interest Rate for Leases – IFRS 16 Requirement (2025 Edition) provides a comprehensive and practical framework for determining lease discount rates in compliance with IFRS 16.26.

Under IFRS 16, lease payments must be discounted using the interest rate implicit in the lease, if it can be readily determined. When this is not possible, the lessee’s Incremental Borrowing Rate (IBR) must be applied. According to IFRS 16, IBR represents the rate a lessee would have to pay to borrow funds over a similar term, with similar security, to obtain an equivalent value to the right-of-use asset in a comparable economic environment.

Key Components of the Discount Rate

Determining the appropriate IBR involves assessing several factors including currency, lease term, asset type, and economic environment. The discount rate is typically composed of three core elements:

1. Risk-Free Rate – Serves as the baseline for calculating IBR.

2. Financing Spread Adjustment – A yield spread is added based on credit ratings from agencies such as S&P, Moody’s, and Fitch. For entities without a formal rating, a synthetic credit rating is estimated using interest coverage ratios and default spreads from traded bonds.

3. Lessee-Specific Adjustment – Reflects company-specific borrowing characteristics and market conditions.

Additional Considerations

• Most corporations borrow on an unsecured basis. To estimate a secured borrowing proxy, Bloomberg’s notching approach (+1 for Ba3/BB– or higher, +2 for B1/B+ or lower) can be applied, aligning with Moody’s methodology.

• For non-U.S. leases, a country risk premium is added to account for differences in economic environments, ensuring a realistic and location-specific borrowing rate.

This Best Practice package includes:

• A fully editable Excel Spreadsheet to help calculate the Incremental Borrowing Rate accurately, step by step.