Incremental Borrowing Rate (IBR) Explained

What the incremental borrowing rate is

IFRS 16 defines the incremental borrowing rate (IBR) as 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.

In plain terms, the IBR is the interest rate the business would be charged if it borrowed money from a bank to buy that specific type of asset over the same period as the lease.

It is not a single fixed rate; it should reflect the characteristics of the specific lease.

Why the IBR matters

The discount rate has a significant effect on the lease liability. A higher discount rate produces a lower present value of future payments and therefore a smaller lease liability. A lower rate produces a larger liability.

For businesses with a large number of leases, the difference between a well-supported and a poorly-supported IBR can be material to the balance sheet. Auditors are aware of this and will test the rate used.

Using an inappropriately low IBR inflates the lease liability. Using an inappropriately high IBR understates it. Either error can affect reported leverage ratios, net debt and interest expense.

When the IBR is used

The IBR is used when the rate implicit in the lease cannot be readily determined. The rate implicit in the lease is defined as the rate that causes the present value of the lease payments plus the unguaranteed residual value to equal the fair value of the underlying asset plus the lessor's initial direct costs.

In practice, lessees rarely have access to all the information needed to calculate the implicit rate. The lessor's unguaranteed residual value is typically unknown, and the fair value of the underlying asset at commencement may not be available or verifiable. As a result, the IBR is the rate used by most lessees in most situations.

What factors affect the IBR

The IBR is not simply the company's average borrowing cost. It should reflect:

• Lease term: a five-year lease requires a five-year borrowing rate; a ten-year lease requires a ten-year rate. Rates increase with term in most interest rate environments.
• Asset type and quality as collateral: a secured loan against a property asset typically carries a lower rate than unsecured finance. The IBR should reflect the type of security the leased asset would represent.
• Currency: if the lease is denominated in a foreign currency, the IBR should reflect borrowing in that currency, not the entity's functional currency rate.
• Company credit quality: the rate should reflect the borrowing cost available to the specific entity at the relevant date, not a generic market rate.
• Economic environment: base rates and credit spreads change over time. The IBR should reflect conditions at the commencement date of the lease (or transition date for existing leases on transition).

Practical approaches to determining the IBR

Finance teams typically use one of the following approaches:

Reference to actual borrowing facilities

Where the business has existing borrowing facilities, the interest rate on those facilities may serve as a starting point. Adjustments may be needed for term differences, collateral differences, or changes in credit conditions since the facility was arranged.

Risk-free rate plus credit spread

A common approach is to take an observable risk-free rate (such as a government bond yield for the appropriate term and currency) and add a credit spread that reflects the entity's borrowing cost. The credit spread may be determined from recent borrowing transactions, credit facility pricing, or market comparables.

Banker's quote

Some businesses obtain a rate indication from their bank for a hypothetical secured borrowing of similar term and amount. This can provide external support for the rate, though it requires the bank to provide a specific indication rather than a general rate range.

Published IBR tools and benchmarks

Several accounting advisory firms and data providers publish IBR benchmark rates by term, currency and credit rating. These can be used as a reference, provided the entity adjusts for its own circumstances and documents the basis for any adjustments.

If you want to build a rate rather than read about one, the free incremental borrowing rate calculator assembles the risk-free rate, credit spread and asset adjustment into a single rate, interpolates a term-matched rate off a yield curve, and will also solve for the rate implicit in the lease.

How to calculate the IBR: a worked example

The build-up approach is additive. Each component is separately observable or evidenced, which is what makes the resulting rate defensible in an audit file:

IBR = term-matched risk-free rate + entity credit spread + asset and security adjustment

Take a five-year property lease with rent of £50,000 payable annually in arrears, commencing 1 January 2026.

Discounting five payments of £50,000 at 5.60% gives a lease liability at commencement of £212,930. The undiscounted payments total £250,000, so £37,070 is recognised as interest across the lease term rather than as rent.

What a one percentage point error costs

The same lease, discounted at rates one percentage point either side:

A one percentage point error moves this single liability by roughly £5,700 to £6,000, a little under 3%. The proportional effect is broadly the same on every lease of similar length, so on a register of any size an unsupported rate misstates the balance sheet consistently rather than randomly. That is why auditors test the rate rather than sampling the arithmetic.

Calculating the present value in a spreadsheet

The liability is a standard annuity calculation. With the rate in B1, the number of periods in B2 and the payment in B3, =PV(B1, B2, -B3) returns the liability for payments in arrears. Add a fifth argument of 1, so =PV(B1, B2, -B3, 0, 1), for payments in advance, which is the more common commercial lease. To convert an annual rate to a monthly one, use =(1+B1)^(1/12)-1 rather than dividing by twelve, so the compounding is right.

A spreadsheet gets you the number. What it does not get you is the evidence trail behind the rate, which is the part the auditor actually challenges.

How to document the IBR judgement

Auditors will expect written documentation of the IBR at the time it was determined. Retroactively constructing documentation during the audit is unlikely to be acceptable. The documentation should include:

• The rate used for each lease (or lease group)
• The method used to determine the rate
• The base rate or reference rate, with a source
• How the rate was adjusted for term, currency, collateral and credit quality
• Any external data or benchmarks referenced
• The date the rate was determined
• Who approved the rate and reviewed the documentation

Common audit questions on the IBR

Finance teams should be prepared to answer:

• Why was this specific rate used rather than the company's weighted average cost of debt?
• How does the rate vary across leases of different terms?
• What adjustments were made for secured versus unsecured borrowing?
• How was the credit spread determined?
• Was the rate determined at commencement, or was a later rate used?
• If a portfolio approach was used, how were leases grouped and why?

How AuditLease records discount rate rationale

AuditLease requires finance teams to record an accounting judgement for the discount rate on each lease as part of the workflow. This written rationale is stored alongside the calculation, creating an integrated evidence trail: the rate, the reasoning behind it, and the resulting liability are all linked together.

When auditors review the evidence, they can see not just the number, but the documented basis for it.

Frequently asked questions

Want to see the effect of a rate before committing to it? Our free incremental borrowing rate calculator builds a rate from its components and shows the liability sensitivity, and the IFRS 16 lease liability calculator lets you test it against a full payment schedule.

This guide is for general information only. The appropriate incremental borrowing rate depends on specific circumstances and should be determined with reference to qualified accounting advice where needed.