Key Takeaways
- IFRS 16 requires the rate implicit in the lease when it is readily determinable, but in practice the lessee almost always defaults to the incremental borrowing rate.
- A 50-basis-point difference in the discount rate on a ten-year lease with €400,000 annual payments shifts the lease liability by approximately €30,000.
- The rate must reflect the specific lease's term, currency, collateral, and economic environment at commencement.
- Applying one blanket rate across a portfolio of leases with different characteristics is the single most common inspection finding on IFRS 16 discount rates.
What is Discount Rate in Lease Accounting?
IFRS 16.26 sets a two-tier hierarchy. The lessee discounts future lease payments at the rate implicit in the lease if that rate can be readily determined. The implicit rate is the rate that causes the present value of the lease payments plus the unguaranteed residual value to equal the sum of the fair value of the underlying asset and any initial direct costs of the lessor (IFRS 16 Appendix A). Lessees rarely have access to the lessor's residual value assumptions, so the implicit rate is unavailable for most leases.
The fallback is the lessee's incremental borrowing rate. This is not a generic weighted average cost of capital. IFRS 16.BC161 specifies that the IBR must reflect what the lessee would pay to borrow over a similar term, with similar security, to obtain an asset of similar value in the same economic environment. Each lease therefore demands its own rate (or, at minimum, a rate built from a common reference point with lease-specific adjustments).
After commencement, the discount rate stays fixed unless IFRS 16.40 triggers a remeasurement. Remeasurement events include a change in the assessed lease term or a change in the assessment of a purchase option. When remeasurement occurs, the lessee applies a revised discount rate reflecting conditions at the remeasurement date. ISA 540.13(b) requires the auditor to evaluate whether the data and assumptions underlying the rate are appropriate for the method applied.
Worked example: Henriksen Shipping A/S
Client: Danish maritime logistics company, FY2025, revenue €140M, IFRS reporter. On 1 April 2025, Henriksen signs an eight-year lease on a 3,800 m² port-side warehouse facility in Aarhus. Annual lease payments are €410,000, payable at the end of each year. The lessor does not disclose the implicit rate. No extension option exists.
Step 1 — Identify the reference rate
Henriksen has a six-year secured term loan with Danske Bank at 3.60%, arranged in January 2025. The treasury team uses this as the starting point.
Documentation note: file the loan agreement as the reference rate source. Record the date, term, currency, and collateral profile of the facility per IFRS 16.BC161.
Step 2 — Adjust for tenor mismatch
The lease runs eight years, but the reference facility is six years. Henriksen derives a 20-basis-point tenor adjustment from the spread between six-year and eight-year Danish government bond yields observed on 1 April 2025.
Documentation note: record the yield curve source (Nationalbanken published yields), the observed spread, and the rationale for applying this sovereign spread to the corporate rate.
Step 3 — Adjust for collateral differential
The term loan is secured against Henriksen's receivables portfolio. The warehouse lease provides different collateral (a single fixed-location property). Henriksen adds a 10-basis-point adjustment to reflect the lower liquidity of property collateral versus receivables.
Documentation note: record the basis for the collateral adjustment. Reference IFRS 16.BC162, which requires the rate to reflect the nature of the underlying asset as security.
Step 4 — Determine the final discount rate and measure the liability
Reference rate 3.60% plus tenor adjustment 0.20% plus collateral adjustment 0.10% gives a discount rate of 3.90%. Henriksen discounts eight annual payments of €410,000 at 3.90%, producing a lease liability of €2,766,214 at commencement.
Documentation note: record the full rate build-up in a single schedule. Attach the present value calculation and cross-reference to the right-of-use asset initial measurement under IFRS 16.24.
Conclusion: the discount rate of 3.90% is defensible because each adjustment layer traces to an external data point, and the build-up reflects the specific lease rather than an entity-wide average.
Why it matters in practice
- The AFM's 2022 financial reporting supervision report flagged entities applying a single discount rate across all leases regardless of differences in term, currency, or collateral. IFRS 16.26 requires a rate specific to each lease. A blanket 4% applied to a two-year equipment lease and a twelve-year property lease in different jurisdictions does not satisfy the standard.
- Teams frequently fail to revise the discount rate when remeasurement is triggered. IFRS 16.40 requires a revised rate at the remeasurement date (for instance, when the lessee reassesses the lease term). Carrying forward the original commencement-date rate after a lease term reassessment in a materially different interest rate environment misstates the remeasured liability.
Discount rate vs. weighted average cost of capital
| Dimension | IFRS 16 discount rate | Weighted average cost of capital (WACC) |
|---|---|---|
| Purpose | Measures a single lease liability at present value | Evaluates investment decisions and entity-level cost of financing |
| Specificity | Calibrated to the individual lease's term, currency, collateral, and economic environment | Blended rate across all debt and equity funding sources |
| Equity component | Excluded entirely; the rate reflects debt-only borrowing costs | Includes cost of equity weighted by capital structure |
| When it changes | Locked at commencement; revised only on remeasurement events under IFRS 16.40 | Updated periodically as market conditions and capital structure shift |
| Audit focus | Tracing each adjustment to an external data point for the specific lease | Reasonableness of beta, market risk premium, and capital weighting assumptions |
The distinction matters because applying WACC to discount lease payments overstates the rate (the equity component inflates it) and understates the lease liability. Auditors who see a WACC-based rate in the lease schedule should flag it as a methodology error, not an estimation difference.
Related terms
Frequently asked questions
How do I build a discount rate for a lease when the entity has no external borrowing?
Start with an observable risk-free rate for the same currency and a similar term, then add a credit risk premium estimated from comparable entities in the same industry and jurisdiction. IFRS 16.BC163 acknowledges that entities without recent borrowings must construct the rate from market data. The auditor tests each component against external sources per ISA 540.18.
Does the discount rate change when lease payments increase with an index?
No. IFRS 16.42 requires the lessee to remeasure the liability for index-linked payment changes using the original discount rate, not a revised one. The rate only changes when IFRS 16.40 applies (lease term reassessment or purchase option reassessment). This distinction catches teams who revise the rate every time CPI-linked rents reset.
Can a group apply a single discount rate to all subsidiary leases?
IFRS 16.BC162 permits using the parent's borrowing rate as a starting point, but the rate must be adjusted for each subsidiary's credit standing, the jurisdiction's economic environment, and the specific lease characteristics. ISA 600.25 requires the group engagement team to evaluate whether component-level assumptions are appropriate. A single unadjusted group rate does not meet either standard.