Determining the Incremental Borrowing Rate for lessees

Correctly estimating the present value of lease payments under ASC 842

The new lease accounting guidance will result in lessees bringing more leases onto their balance sheets. Adoption and implementation of this new guidance can be intimidating, but it doesn’t have to be, with the right professionals by your side.

The new guidance requires lessees to examine a number of factors related to appropriately accounting for their leases. One factor is the determination of an appropriate discount rate to measure the present value of a lessee’s lease payments. In most cases, the interest rate implicit in the lease may not be readily available to lessees, and consequently, calculating the incremental borrowing rate (IBR) is a key requirement to correctly estimate the present value of lease payments.

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Determination of the appropriate IBR is critical for a lessee to accurately account for its leases in accordance with:

  • Topic 842, Leases, of the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC)
  • International Financial Reporting Standard (IFRS) 16, Leases, released by the International Accounting Standards Board

Challenges for implementing the new guidance

The standard-setting bodies provided new definitions and limited guidance on determining the IBR. While certain concepts from prior guidance are present in the new guidance, a full understanding and implementation of the updated definitions will be required for compliance with the new guidance.

The new definition for the IBR in the FASB’s master glossary of the ASC is: “The rate of interest that a lessee would have to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment.”

The definition for the IBR from IFRS 16 is: “The rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment.”

The following components need to be considered and thoroughly documented when determining the IBR:

  • Lessee-specific credit risk
  • Amount of the lease payments
  • Collateralized nature of the lease
  • Alignment of the borrowing term and lease term
  • Economic environment of the lease and foreign currency considerations
  • Quality of the lessee’s collateral

The evaluation of each of these components requires significant professional judgment and proficiency.

Benefits of our valuation approach

We understand that change is difficult and transition requires additional effort from your company. Our extensive experience in preparing defensible and succinct valuations for financial reporting purposes, combined with our ability to qualitatively and quantitatively analyze the IBR components, perfectly situates RSM to be your trusted advisor in helping you to adopt and comply with the new lease guidance.

Applying an IBR that lacks sufficient documentation and alignment with the new guidance can waste your company’s time and resources. Regardless of where you are in your lease accounting transition, our valuation professionals can reduce the complexity of implementation by assisting with the IBR calculation.

The benefits of our approach to determining the IBR include:

  • Access to financial databases that allow for enhanced documentation of valuation inputs
  • Professionals with experience in evaluating fixed-income securities that have similar risk profile components as the ones considered in determining the IBR
  • The information necessary to derive and defend unobservable inputs that influence the IBR

In addition to determining the IBR, RSM provides technical accounting resources, embedded lease identification and physical inspection of assets to service your lease accounting needs holistically. Visit our Lease Accounting Resource Center for further information.

Our valuation professionals

Our professionals hold accreditations with the American Society of Appraisers, the Institute of Business Appraisers, the American Institute of Certified Public Accountants and the CFA Institute.

We are committed to providing reliable deliverables and customized reports for your unique financial reporting needs based on our up-to-date knowledge of accounting and tax compliance issues, regulatory changes and the latest valuation developments.

Don’t risk venturing through uncharted waters alone; contact us to begin a discussion today.

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