Key Points
- The IBR applies only when the interest rate implicit in the lease cannot be readily determined, which is the case for the vast majority of leases.
- Each lease requires its own IBR adjusted for term, currency, security, and the lessee's credit standing at commencement.
- A 50-basis-point error in the IBR on a ten-year property lease with annual payments of €500,000 can shift the lease liability by more than €35,000.
- Auditors focus on whether the entity used a blanket rate across all leases rather than adjusting for individual lease characteristics.
What is Incremental Borrowing Rate?
IFRS 16.26 requires the lessee to measure the lease liability at the present value of the lease payments, discounted using the interest rate implicit in the lease if that rate is readily determinable. In practice, lessees almost never have access to the lessor's underlying asset cost and residual value assumptions needed to compute the implicit rate. The fallback is the IBR.
The IBR is not a single figure pulled from a corporate treasury dashboard. IFRS 16.BC161 confirms that the rate must reflect the specific lease's term, the nature and quality of the security (the underlying asset itself), and the economic environment at the commencement date. A five-year equipment lease and a fifteen-year property lease signed on the same day by the same entity will typically carry different IBRs.
Lessees commonly start with an observable borrowing rate (a recent bank facility, a bond yield, or a reference rate such as the ECB refinancing rate) and then adjust. Adjustments cover the difference in tenor, the collateral profile of the leased asset versus the reference borrowing, and any currency mismatch. ISA 540.13(b) requires the auditor to evaluate whether the data and significant assumptions used to determine the IBR are appropriate for the method applied. That evaluation means tracing the reference rate to a source document and testing each adjustment for reasonableness.
Worked example
Client: Spanish wholesale distribution company, FY2025, revenue €34M, IFRS reporter. On 1 July 2025, Fernández signs a seven-year lease on a 6,200 m² logistics warehouse near Valencia. Annual lease payments are €280,000, payable at the end of each year. The lessor does not disclose the implicit rate.
Step 1 — Identify the reference rate
Fernández has a five-year secured revolving credit facility with Banco Santander at a fixed rate of 3.80%, arranged in March 2025. The treasury team uses this as the starting point for the IBR.
Documentation note: file the facility agreement as the reference rate source. Record the date, tenor, and collateral terms of the facility per IFRS 16.BC161.
Step 2 — Adjust for tenor
The lease runs seven years, but the reference facility is five years. Fernández applies a 25-basis-point tenor adjustment derived from the spread between five-year and seven-year Spanish government bond yields observed on the commencement date.
Documentation note: record the yield curve data source (e.g., Banco de España published yields on 1 July 2025), the observed spread, and the basis for applying it to the corporate rate.
Step 3 — Adjust for security
The revolving credit facility is secured against receivables. The leased warehouse provides weaker collateral than a receivables pool because it is a single illiquid asset in a specific location. Fernández adds a 15-basis-point adjustment for the collateral differential.
Documentation note: record the rationale for the collateral adjustment, referencing comparable property-backed loan margins if available. Cite IFRS 16.BC162 for the requirement to reflect the nature of the underlying asset.
Step 4 — Determine the final IBR
Reference rate 3.80% plus tenor adjustment 0.25% plus collateral adjustment 0.15% = IBR of 4.20%. Fernández discounts seven annual payments of €280,000 at 4.20%, producing a lease liability of €1,660,378 at commencement.
Documentation note: record the IBR build-up in a single schedule showing each adjustment layer. Attach the present value calculation. Cross-reference to the right-of-use asset initial measurement under IFRS 16.24.
Conclusion: the IBR of 4.20% is defensible because each component is traceable to an external data point, and the adjustments reflect the specific lease rather than the entity's generic cost of borrowing.
Why it matters in practice
The AFM's 2022 report on financial reporting supervision noted that lessees frequently applied a single discount rate across all leases regardless of differences in term, currency, or collateral. IFRS 16.26 requires a rate specific to the individual lease. A blanket rate applied to a portfolio spanning five-year equipment leases and fifteen-year property leases does not meet the standard.
Teams often reuse the IBR determined at commencement when remeasuring the lease liability after a lease modification or reassessment of a lease term. IFRS 16.40 requires a revised discount rate at the date of reassessment, reflecting conditions at that date rather than the original commencement date. Carrying forward the old rate after a material change in market conditions misstates the remeasured liability.
Incremental borrowing rate vs. rate implicit in the lease
| Dimension | Incremental borrowing rate | Rate implicit in the lease |
|---|---|---|
| Who determines it | The lessee, based on its own borrowing capacity and adjustments for lease-specific factors | Derived from the lessor's asset cost, residual value estimate, and lease payment structure |
| Availability | Always determinable by the lessee | Rarely available because lessees lack access to the lessor's residual value assumption |
| IFRS 16 hierarchy | Fallback rate used when the implicit rate is not readily determinable (IFRS 16.26) | Preferred rate under IFRS 16.26 when it can be readily determined |
| Typical magnitude | Generally higher, because it does not capture the lessor's residual value benefit | Generally lower, because the lessor's expected residual value recovery reduces the rate |
| Audit focus | Verifying the reference rate source, each adjustment, and the lease-specific calibration | Verifying the lessor's residual value and cost assumptions (rarely tested in practice because the implicit rate is rarely used) |
The distinction matters because using the implicit rate (when available) typically produces a lower lease liability and right-of-use asset. If a lessee has access to the implicit rate but defaults to the IBR out of convenience, it overstates both the liability and the asset on the balance sheet.
Related terms
Frequently asked questions
How do I document the incremental borrowing rate for audit purposes?
Prepare a build-up schedule starting from an observable reference rate, then show each adjustment (tenor, collateral, currency, credit standing) as a separate line with its source. IFRS 16.BC161 expects the rate to reflect the specific lease's characteristics. The auditor will test each adjustment against external market data, so the file must contain the data points, not just the final number.
Does the incremental borrowing rate change during the lease?
The IBR is locked at the commencement date and remains fixed for the life of the lease unless a remeasurement event occurs. IFRS 16.40 triggers a revised rate when the lessee reassesses the lease term or reassesses whether it is reasonably certain to exercise a purchase option. Routine changes in market interest rates do not trigger a revision on their own.
Can a group use the parent's borrowing rate for subsidiary leases?
IFRS 16.BC162 permits using a parent's rate as a starting point but requires adjustment to reflect the subsidiary's own credit standing and the economic environment in which the subsidiary operates. A subsidiary in a different jurisdiction with a different risk profile cannot adopt the parent rate without adjustment. ISA 600.25 requires the group engagement team to evaluate whether the component's lease accounting assumptions are appropriate.