Which rate should a lessee use?
The rate implicit in the lease is the rate that makes the present value of the lease payments and any unguaranteed residual value equal to the fair value of the asset plus the lessor's initial direct costs. A lessee rarely knows the lessor's residual value assumptions or costs, so it can seldom determine this rate. It then uses its incremental borrowing rate.
How is an incremental borrowing rate built?
- Reference rate. Start with a rate for the currency and term of the lease, such as a government bond yield or swap rate.
- Credit spread. Add the spread the lessee would pay given its credit standing, from its own borrowings, bond yields or comparable companies. In a group, consider whether the lessee subsidiary borrows on its own credit or with parent support.
- Lease-specific adjustments. Adjust for the term, the security provided by the right to use the asset, the currency and the economic environment of the lessee.
Leases with similar characteristics, such as a portfolio of vehicle leases, may share one rate.
How much does the rate matter?
| Discount rate | Liability for five payments of CU 100,000 | Change from 5% |
|---|---|---|
| 4% | CU 445,182 | +2.8% |
| 5% | CU 432,948 | None |
| 6% | CU 421,236 | -2.7% |
A lower rate gives a larger liability and asset, more depreciation and less interest. For long property leases the effect is much larger: on a 20-year lease, a one-point change moves the liability by about 8 to 9 per cent. Try different rates in the Lease calculator (Excel).
A worked example
A retailer leases a store for five years. Five-year government bonds in its currency yield 3.50%. Its own five-year bank borrowing would cost about 2.00 points over that, unsecured. Because a lender would value the security of the store lease, the retailer deducts 0.50 points, giving an incremental borrowing rate of 5.00%. It documents each input and its source, which is what auditors look for.
When does the rate change?
| Event | Discount rate used |
|---|---|
| Change in lease term or purchase option assessment | Revised rate at that date |
| Modification not accounted for as a separate lease | Revised rate at the modification date |
| Change in payments from an index or rate, such as inflation | Original rate, unless floating interest rates changed |
| Change in amounts expected under a residual value guarantee | Original rate |
See lease modifications.
What do auditors ask for?
A written methodology showing each building block and its source, such as the bond yield, the credit spread from recent borrowing or quotes, and the security adjustment, applied consistently across the lease portfolio. They will test whether the rate reflects the lease term and currency, and whether rates for new leases are updated as market rates move. A portfolio of similar leases, such as company cars with similar terms, may use a single rate. The approach is then explained in the notes; see IFRS 16 disclosures.
What rate does a lessor use?
Always the rate implicit in the lease. A lessor knows the asset's fair value, its own initial direct costs and its residual value assumptions, so it can always calculate that rate. See lessor accounting.
US GAAP differs: private companies may elect a risk-free rate; see the ASC 842 discount rate.
Common mistakes
- Using the company's average cost of borrowing without adjusting for the lease term.
- Using a parent's rate for a subsidiary that borrows on its own.
- Using one rate for leases in different currencies.
Need help applying the standards?
Our Chartered Accountants help finance teams and students apply IFRS and US GAAP to real transactions.
Questions people ask
What discount rate does IFRS 16 require?
The rate implicit in the lease if readily determinable; otherwise the lessee's incremental borrowing rate.
What is the incremental borrowing rate?
The rate the lessee would pay to borrow, over a similar term and with similar security, the funds needed to obtain an asset of similar value in a similar economic environment.
How is an incremental borrowing rate estimated?
From a reference rate for the currency and term, plus the lessee's credit spread, adjusted for security and other lease features.
When is a lease liability remeasured with a new discount rate?
On a change in the lease term or purchase option assessment, and on modifications that are not separate leases.
Sources
Every fee, date and rule on this page was taken from these official and primary sources.
Rules and fees change. If you are reading this long after October 4, 2026, confirm the figures with the source before you rely on them.
Related guides
More in IFRS 16
This guide is general information. It is not tax or legal advice for your situation.