Discount rates are also used to determine lease classification for a lessor and to measure a lessor’s net investment in a lease.
For lessees, the lease payments are required to be discounted using:
- the interest rate implicit in the lease (IRIL), if that rate can be readily determined, or
- the lessee’s incremental borrowing rate (IBR).
For lessors, the discount rate will always be the interest rate implicit in the lease. The interest rate implicit in the lease is defined in IFRS 16 as ‘the rate of interest that causes the present value of (a) the lease payments and (b) the unguaranteed residual value to equal the sum of (i) the fair value of the underlying asset and (ii) any initial direct costs of the lessor.’
The lessee’s incremental borrowing rate is defined in IFRS 16 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’.
Under IFRS 16 ‘Leases’, discount rates are used to determine the present value of the lease payments used to measure a lessee’s lease liability.