To calculate the incremental borrowing rate, you build a hypothetical loan that mirrors a specific lease — matching its term, currency, payment size, and your credit profile on a fully collateralized basis — and then derive the interest rate that loan would carry at the lease commencement date. Lessees under ASC 842 and IFRS 16 must use this rate to discount future lease payments whenever the rate implicit in the lease is not readily determinable, which is almost always the case because the implicit rate depends on lessor data the lessee cannot see.1DART – Deloitte Accounting Research Tool. Chapter 7 — Discount Rates – 7.1 General
No single formula produces the number. The IBR is the output of a short modeling exercise: define the loan, pick a method to price it, and apply adjustments so the final rate reflects the lease’s actual economics rather than a generic company-wide borrowing cost.
What the IBR Has to Represent
Under ASC 842, the IBR is the rate you would pay to borrow, on a collateralized basis and over a similar term, an amount equal to the lease payments in a similar economic environment.1DART – Deloitte Accounting Research Tool. Chapter 7 — Discount Rates – 7.1 General Under IFRS 16, the rate is sized to the value of the underlying right-of-use asset rather than to the total payments.2IFRS Foundation. Lessee’s Incremental Borrowing Rate (IFRS 16) For most leases the two amounts are close enough that the resulting rate barely differs, but for a short-term lease on expensive equipment the IFRS 16 version can produce a meaningfully different number. Confirm the standard you report under before you begin.
A single company-wide rate applied to every lease will not satisfy either standard. Each lease carries its own economic profile and needs its own rate.
Five Inputs That Define the Hypothetical Loan
Before you pick a calculation method, lock down the facts that describe the loan you are pretending to take out.
- Lease term. The borrowing’s maturity must match the lease term. A 10-year lease carries more interest-rate and credit risk than a two-year lease, and the rate for the longer term will generally be higher.
- Currency. If payments are denominated in a foreign currency, the IBR must reflect borrowing costs in that currency. Sovereign credit risk and local interest-rate conditions can push the rate significantly higher or lower than your home-currency cost of funds.
- Credit profile. Your creditworthiness is the single biggest driver of the spread above the risk-free rate. A highly rated entity will land a much lower IBR than a speculative-grade borrower.
- Collateral. Under ASC 842, assume full collateralization, neither under nor over. The collateral does not have to be the leased asset itself; it can be any form a creditor would accept for a loan of similar term, as long as it is at least as liquid as the leased asset.1DART – Deloitte Accounting Research Tool. Chapter 7 — Discount Rates – 7.1 General
- Commencement date and economic environment. The IBR is anchored to prevailing market rates as of the lease commencement date. A lease signed during a low-rate environment carries a different IBR than an otherwise identical lease signed two years later.
Skipping or generalizing any of these is the fastest way to end up with a rate that neither reflects the lease’s actual risk nor survives audit scrutiny.
Subsidiary or Parent Credit?
When a subsidiary is the lessee, the default is its own creditworthiness. Many corporate groups, however, manage borrowing centrally through a parent-level treasury function. If the parent guarantees the lease or the lessor priced the deal off the parent’s standing rather than the subsidiary’s, using the parent or consolidated-group IBR can be appropriate. ASC 842 includes an example concluding that subsidiaries should use the parent’s IBR when treasury is centralized and the parent’s credit profile more significantly influenced the lease pricing.
Three Methods for Pricing the Loan
Most entities arrive at an IBR by one of three routes, or by combining them. Which one fits depends on what observable data you already have.
Start From Existing Debt
If you have recently issued bonds or drawn on a bank facility with a comparable term, that rate already bakes in your credit risk and the current market environment. Use it as the starting point. The work is in the adjustments. If the existing debt has a shorter maturity than the lease, push the rate upward to account for additional duration risk. If the existing debt is unsecured but the IBR assumes full collateralization, adjust downward to reflect the lower risk a lender faces on a secured loan. Quantifying those adjustments takes judgment, but you are building from a verifiable internal data point rather than modeling from scratch.
Use a Credit Rating Yield Curve
When comparable debt isn’t available, published yield curves fill the gap. Market data providers plot yields against maturities for each credit rating tier — ‘A’, ‘BBB’, and so on. Identify the yield on the curve that matches your rating at the specific lease term. That yield represents an unsecured borrowing cost, so apply a downward adjustment to reflect the collateralized nature of the IBR. The method works well for public companies with established ratings and produces a rate anchored to observable market transactions, which strengthens its defensibility with auditors.
Build Up From the Risk-Free Rate
For private companies or entities without a formal credit rating, the most flexible approach starts from the bottom. The risk-free rate, typically the yield on government bonds matching the lease term, is the theoretical minimum cost of borrowing. On top of that, add a credit spread derived from analyzing spreads of comparable-rated companies in the same industry. Then apply a final adjustment for the collateral effect. The three-layer construction yields a fully customized IBR even when you have no public debt history to reference.
A Portfolio Rate When You Have Many Leases
Calculating a unique IBR for every lease is impractical for entities managing hundreds of contracts. ASC 842 permits a portfolio approach: you may apply a single discount rate to a group of new leases entered into during the same period, provided those leases share similar terms and your credit rating and the interest-rate environment remained stable over that period.3Deloitte Accounting Research Tool. 7.2 Determination of the Discount Rate for Lessees
The portfolio must be stratified carefully enough that the result does not materially differ from a lease-by-lease calculation. Attributes to weigh when grouping leases include the lease term, the type of underlying collateral, and the size of the payments. A portfolio of 400 four-to-five-year office leases signed in the same quarter can reasonably share one rate. A mix of two-year copier leases and 15-year warehouse leases cannot.3Deloitte Accounting Research Tool. 7.2 Determination of the Discount Rate for Lessees
The Risk-Free Rate Election for Private Companies
Private entities that are not public business entities have a simpler option. FASB ASU 2021-09 allows them to elect the risk-free rate as their discount rate instead of calculating a full IBR.4FASB. Leases (Topic 842) – ASU 2021-09 The election can be made by class of underlying asset, so a company might use the risk-free rate for vehicle leases and calculate a traditional IBR for real estate leases, or the other way around.
A risk-free rate is easier to determine and defend because it relies on published government bond yields with no credit-spread analysis. The trade-off is that the risk-free rate is lower than any entity’s actual borrowing cost, which produces a higher lease liability on the balance sheet. For lessees seeking financing or otherwise sensitive to balance sheet optics, the administrative savings may not be worth it. The election must be disclosed, including which asset classes it applies to. And regardless of the election, if the rate implicit in any individual lease is readily determinable, that rate still takes priority.4FASB. Leases (Topic 842) – ASU 2021-09
When You Have to Recalculate
The IBR set at commencement does not automatically carry through the life of the lease. Some events require remeasuring the lease liability, and some of those events also require a fresh discount rate.
Under ASC 842, you must remeasure the liability and update the discount rate when the lease term changes, for example if you become reasonably certain to exercise a renewal option you previously expected to decline. The same applies when your assessment of a purchase option changes. In both cases the updated rate is the IBR as of the remeasurement date, not the original commencement date.
Lease modifications that change the scope or consideration of the lease also trigger remeasurement. If the modification is not treated as a separate new lease, you remeasure using a revised discount rate determined at the modification’s effective date.
Under IFRS 16, a change in lease payments resulting from a change in a floating index or rate triggers a remeasurement of the liability. The discount rate treatment differs by trigger: IFRS 16 requires an updated rate for some remeasurement events and retains the original rate for others. Map each triggering event to the correct rate treatment before booking the entry. Events that do not trigger a rate update, such as simple adjustments for changes in variable payments that depend on an index under ASC 842, use the original commencement rate.
Documenting the Rate
A defensible IBR is only as strong as its documentation. Auditors expect a written methodology, often called an ASC 842 IBR report, that walks through the inputs, the data sources, the chosen calculation method, and every adjustment applied. Align on methodology with your auditor before you finalize the rate. Reconstructing the rationale months later is painful and often unconvincing.
At a minimum, document the starting rate and its source, the lease-specific inputs (term, currency, credit profile, collateral type), each adjustment and its basis, and the final calculated rate. If you use the portfolio approach, document how leases were grouped and why the grouping produces results materially consistent with a lease-by-lease calculation.
On the reporting side, ASC 842 requires lessees to disclose the weighted-average discount rate separately for operating leases and finance leases, along with qualitative and quantitative information about the significant judgments made in applying the standard, including how the discount rate was determined.4FASB. Leases (Topic 842) – ASU 2021-095Deloitte Accounting Research Tool. Lessee Disclosure Requirements SEC registrants face additional scrutiny; staff comment letters have specifically asked companies to clarify whether rates implicit in their leases are readily determinable and to explain the basis for using the IBR instead.