A guide to the incremental borrowing rate

The issuance of IFRS 16 Leases has resulted in two major changes: the inclusion of operating leases on the balance sheet and the way expenses are recorded in the income statement. As a result, a significant number of Swiss companies expect to see material changes in the presentation of their financial statements.

The discount rate assumption could have the largest quantitative impact on the lease asset and liability valuations. It is therefore one of the most crucial judgements that management will have to make.

This brochure outlines the different options Swiss companies can use to meet this requirement. It also explains the approaches financial statements preparers can use to select the appropriate discount rates – both during the transition phase and on an ongoing basis.

Key messages

1. Many companies are grappling with the challenges of readily determining, for each lease, the interest rate implicit in the lease (“IRIIL”) and so need to determine an incremental borrowing rate (“IBR”). In addition, those considering one of the modified transition approaches will be required to use the IBR at the date of initial application.
2. There are a number factors to consider in determining an incremental borrowing rate, many of which need data points in order to be able to reliably quantify any necessary adjustments to arrive at the final discount rates.
3. Common data points used to start determining an incremental borrowing rate are relevant interest rate yield curves as well as government and corporate bond rates. However, repayment profiles for these can differ from the payment profile of an individual lease. Care needs to be taken to avoid defaulting to the full duration of the lease term when selecting appropriate data points.
4. Another source of data which can help benchmark the incremental borrowing rate is property yields. However it is difficult to quantitatively adjust these rates to arrive at an incremental borrowing rate.
5. Companies are already starting to document their methodologies for determining incremental borrowing rates and in doing so are identifying some of the more subtle complexities and judgements required.