Incremental borrowing rate | IFRS 16

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anmicha
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Incremental borrowing rate | IFRS 16

Post by anmicha »

Quite disappointed and frustrated by IBR's level of analysis. First of all, the standard's guidelines are super general (in contrast to a US standard). Second, it seems that no one really knows what the discount rate should be and everyone uses a discount rate that suits reporting purposes.
Here are some of my wonderings:
If lease payments are CPI-linked then should a discount rate be real (not nominal)?
If a profitable private company isn't leveraged then the discount rate may be at the level of a risk-free interest rate (approximately 0).
Asking from banks for quotes of interest rates for the loan to lease different properties for different periods is simply impractical.
Has anyone faced similar issues? How do you determine IBR?

Thank you.
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Marek Muc
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Re: Incremental borrowing rate | IFRS 16

Post by Marek Muc »

Hi, this is a point that is high on my list when it comes to expanding the knowledge base:) I hope we will see other people sharing their approaches to this matter on this forum, but probably it is at a too early stage of development yet.

As I talked to my colleagues offline, they mostly adopt a simplified approach – they use actual borrowing rate of their entity for all leases (or nearly all). Such a rate is then adjusted to reflect different maturities for leases where the lease term differs significantly from the average maturity of the debt. But generally, I haven’t heard someone doing complex calculations or getting quotes from banks.
If lease payments are CPI-linked then should a discount rate be real (not nominal)?
The lease payments used in the measurement of the lease should be based on actual CPI at the measurement date, see here, and therefore a discount rate should be nominal in my opinion, what are your thoughts?
If a profitable private company isn't leveraged then the discount rate may be at the level of a risk-free interest rate (approximately 0).
I would not agree. Even a profitable company is not risk-free, some credit spread needs to be taken into account. I think that the section on cost of debt might be a useful starting point for you.

Feel free to come back with more questions, this is indeed an important topic to be discussed.

Marek
anmicha
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Re: Incremental borrowing rate | IFRS 16

Post by anmicha »

First of all, well done on the forum and the website!

Regarding CPI-linked payments - from digging in Basis for Conclusions (BC 166) I understand that interest rate should be nominal.
In the reports of similar companies, I see a significant difference between discount rates.
In my opinion, this is an opening for manipulation. Most of the focus today seems to be directed at the issues that are the outcome of interest rate determination instead at the IBR itself.
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Marek Muc
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Re: Incremental borrowing rate | IFRS 16

Post by Marek Muc »

First of all, well done on the forum and the website!
thanks :)
Regarding CPI-linked payments - from digging in Basis for Conclusions (BC 166) I understand that interest rate should be nominal.
OK so we agree that this should be a nominal interest rate.
In the reports of similar companies, I see a significant difference between discount rates.
If you did some research, it would be great if you shared it here!
In my opinion, this is an opening for manipulation.
Well, IFRS are principle-based and therefore judgement plays an important role. It would take lots of pages to list all areas open to manipulation in IFRS reporting :) But even if we stick to IFRS 16, a lease liability depends heavily on determination of lease term. For example, when a 10-year lease has an extension option for another 5 years, it's up to management judgement whether the lease liability will reflect 10 or 15 years worth of lease payments. And this will have a much more significant impact on the lease liability than the discount rate itself.
Gibby0821
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Re: Incremental borrowing rate | IFRS 16

Post by Gibby0821 »

Hi All,

New joiner here.
I would love to follow this topic also and see how others perceive IBR determination.
What we observed in practice is a plethora of methodology:
a. Build-up approach that starts from a reference rate, adjusts lease specific risks factors. KPMG and Deloitte have published some useful guidance on this.
b. Some default to bank loans that they have to extract credit spread and add it to a reference rate like USD LIBOR for USD denominated leases.
c. Some use risk-free rates like government bond rates without any adjustment.
b. Banks on the other hand leverage to their FTP process

And I think as I discuss with my colleagues, diverse views across practices and industry exist especially debates around adding asset risk premium etc.

I agree with Marek that IFRS is principles-based and will really depend on the judgment. But again, I hope practice develops good methodology and realizes from the lessons learned in IAS 19 and IAS 37. IASB has been running discount rate research but I have not seen IFRS 16 discussed there.

Any thoughts?

- Gibby
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Marek Muc
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Re: Incremental borrowing rate | IFRS 16

Post by Marek Muc »

Hi Gibby, first of all – welcome to the Forum, I hope we’ll have many fruitful discussions here :)

To be honest, I’m not an optimist in this area, I think that the diversity in practice is here to stay. The IASB research project on discount rates in IFRS was launched many years ago, so IFRS 16 could not have been included in the scope.

In my opinion, approach b. from your post is the most useful one, as it starts with an actual and entity specific rate.

Which one is your favourite?
pdolci
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Re: Incremental borrowing rate | IFRS 16

Post by pdolci »

Hi everybody,

sorry to come back to an "ancient post" like this, but my company is facing a new issue on IBR.
Our construction of the IBR starts with the cost of financing as derived from our publicy issued bonds.

Due to market conditions, these rates (spread included) are currently negative for the next 3 to 4 years, giving an IBR that's negative for the first 4 years and then becomes (mildly) positive for the rest of the curve.

In my opinion it is counterintuitive to have a negative IBR that would result in a revaluation of the future cash flows instead of a discount.
I was wondering if a more sensible way to approach this would be to put zero as value as long as the IBR is in the negative sector.

Has anyone gone through a similar problem ?
Please let me know.

Best regards,
Paolo
JRSB
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Re: Incremental borrowing rate | IFRS 16

Post by JRSB »

Interesting one. In fact I have no idea but if the lease liability is considered for this purpose effectively as borrowing, then why wouldn't a negative interest rate equally apply...
anmicha
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Re: Incremental borrowing rate | IFRS 16

Post by anmicha »

Hey, I would suggest starting from a risk-free interest rate that is derived from the government bonds yield curve (negative in the euro area) and then adding a default spread that derived from a bond rating.
JRSB
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Re: Incremental borrowing rate | IFRS 16

Post by JRSB »

The chain above asks about 'practice' and whilst there's some good discussion of theory, in practice I've seen it occur that an email to a bank relationship manager saying 'what would you charge if we borrowed £20m over 3 years' (etc), with an answer back 10 mins later, and that was it. ;) ;)
anmicha
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Re: Incremental borrowing rate | IFRS 16

Post by anmicha »

Doesn't work for many contracts in different countries with different maturities.
JRSB
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Re: Incremental borrowing rate | IFRS 16

Post by JRSB »

Send more emails :mrgreen:
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Marek Muc
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Re: Incremental borrowing rate | IFRS 16

Post by Marek Muc »

the issue of negative interest rates is interesting so I thought I will start a new topic, join me there :)

viewtopic.php?f=6&t=519
JRSB
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Re: Incremental borrowing rate | IFRS 16

Post by JRSB »

Normally when accounting rules change, new 'services' pop up, like people selling IFRS 16 calculators.

Surprised there isn't an online resource/service which will provide estimated borrowing rates, in various scenarios, based on anonymous underlying data, whether plugged in to banking networks or by 'data mining' from various annual reports, to supply an indicative borrowing cost, with backing/support, for $100 a pop.

Maybe there is and I haven't seen it...
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Marek Muc
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Re: Incremental borrowing rate | IFRS 16

Post by Marek Muc »

Good question. My initial thought is that a new player wouldn't be reliable enough to use their input in the accounts. Also I think that many entities simply use their actual borrowing rate and don't need additional paid service.

I don't know what's available in Bloomberg or Reuters paid data feeds, this is what larger entities use and an experienced user would probably be able to come up with incremental borrowing rate. There's also Damodaran who publishes really useful data for discount rate determination, but true is takes some time to digest it.
anmicha
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Re: Incremental borrowing rate | IFRS 16

Post by anmicha »

JRSB wrote: 28 Jan 2021, 23:54 Normally when accounting rules change, new 'services' pop up, like people selling IFRS 16 calculators.

Surprised there isn't an online resource/service which will provide estimated borrowing rates, in various scenarios, based on anonymous underlying data, whether plugged in to banking networks or by 'data mining' from various annual reports, to supply an indicative borrowing cost, with backing/support, for $100 a pop.

Maybe there is and I haven't seen it...
There is no need for that. Everyone sends emails to the bank.
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Re: Incremental borrowing rate | IFRS 16

Post by JRSB »

you said that doesn't work before....just a suggestion :mrgreen:
pub_acco
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Re: Incremental borrowing rate | IFRS 16

Post by pub_acco »

Bloomberg provides credit rating vs. credit spread matrixes derived from the corporate bond market. So, I usually just plug the credit rating of my employer to get credit spreads by maturity date and then add them to government bond yields to arrive at IBRs. This obviously doesn't work if an entity doesn't have a credit rating by S&P, etc., and in such a case, I don't really have a better idea than to send emails to banks. In practice though I've seen a company actually take a small amount of long-term loan to get a sense of IBR.
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Re: Incremental borrowing rate | IFRS 16

Post by JRSB »

I wonder what something like this would do to identify IBR? https://leasequery.com/
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