How is the discount rate for lease liabilities determined under IFRS 16?

Under IFRS 16, the lease liability is measured at the present value of future lease payments. The discount rate applied is the interest rate implicit in the lease (IRIL) — but only if that rate can be readily determined. When it cannot, the lessee must use its incremental borrowing rate (IBR) (IFRS 16.26). In practice, the IBR becomes the default rate for most lessees, making it one of the most consequential judgements in lease accounting. - Priority: implicit rate first. The lessee must first attempt to determine the IRIL — the rate that discounts lease payments and the unguaranteed residual value to equal the fair value of the underlying asset plus any initial direct costs of the lessor. Because lessees rarely have access to the lessor's residual value assumptions, the IRIL is seldom "readily determinable," and the IBR steps in as the practical default (IFRS 16.26). - IBR definition and key inputs. The IBR is the rate the lessee would pay to borrow funds — not a risk-free rate, not an equity return, but secured debt. It must reflect: (1) a term consistent with the lease term; (2) an amount equivalent to the right-of-use asset value; and (3) the lessee's own credit quality, currency, and economic environment at the commencement date. This is not a generic market rate — it is entity-specific and lease-specific.

How should a lessee determine the IBR for a foreign-currency lease in a high-inflation jurisdiction under IFRS 16?

- Building the IBR in practice. A common constructive approach begins with an observable reference rate for the relevant currency and tenor (such as a government bond yield or interbank swap rate), then adds a credit spread reflecting the lessee's secured borrowing cost, and adjusts for jurisdiction or collateral differences. The IBR is fixed at the lease commencement date and is not updated simply because market rates move. - When floating rates change. Where lease payments are linked to floating interest rates and those rates change, a revised discount rate is required. IFRS 16.43 is explicit: the lessee shall use an unchanged discount rate unless the change in lease payments results from a change in floating interest rates, in which case a revised discount rate reflecting the change must be applied. - Reassessment triggers requiring a revised rate. A lessee must remeasure the lease liability using a revised discount rate when specific events occur — for example, a change in the lease term or a change in the assessment of a purchase option (IFRS 16.40). More broadly, after the commencement date, IFRS 16.36 governs how the lease liability carrying amount is updated to reflect interest, payments made, and any remeasurements from reassessments or modifications.

When a lease term is reassessed under IFRS 16.20, how is the revised IBR calculated and what is the journal entry for the remeasurement?

- Using a single company-wide IBR. The IBR must reflect the specific lease term, currency, and collateral of each arrangement. A single rate applied to all leases regardless of tenor or jurisdiction will almost certainly be incorrect. - Ignoring the secured nature of the rate. The IBR represents a secured borrowing rate — the lessee's unsecured bond yield is not an appropriate starting point without a downward adjustment for collateral. - Failing to update when required. While the IBR is generally locked in at commencement, lessees sometimes forget to apply a revised rate when IFRS 16.40 or IFRS 16.43 triggers a remeasurement.

Can a lessee use a risk-free rate as a practical expedient instead of the IBR, and if so, under what conditions does IFRS 16 permit this?

- Conflating the lessor's implicit rate with an IBR. For subleases, IFRS 16.68 permits an intermediate lessor, when the implicit rate in the sublease cannot be readily determined, to use the discount rate from the head lease (adjusted for initial direct costs). This is a lessor-specific rule and does not alter the lessee IBR hierarchy. - Misapplying the interest recognition pattern. Interest on the lease liability must produce a constant periodic rate of interest on the remaining balance — the effective interest method — using the rate from IFRS 16.26 (IFRS 16.37). - IFRS 16.26 — Establishes the hierarchy: use the interest rate implicit in the lease if readily determinable; otherwise use the lessee's IBR. The foundational rule for discount rate selection. - IFRS 16.37 — Requires interest on the lease liability to be calculated using the effective interest method, producing a constant periodic rate on the remaining balance. - IFRS 16.40 — Triggers requiring a revised discount rate on remeasurement: change in lease term or change in assessment of a purchase option. - IFRS 16.43 — Specifies that the discount rate remains unchanged unless lease payments vary due to floating interest rate movements, in which case a revised rate must be used. - IFRS 16.36 — Governs subsequent measurement of the lease liability, including increases for interest, reductions for payments, and remeasurements from reassessments or modifications. - IFRS 16.68 — Permits an intermediate lessor to use the head lease discount rate (adjusted for initial direct costs) when the implicit rate in a sublease cannot be readily determined.

IFRS 16 Discount Rate — IBR

IFRS 16 Discount Rate — Core Rule

Under IFRS 16, the lease liability is measured at the present value of future lease payments. The discount rate applied is the interest rate implicit in the lease (IRIL) — but only if that rate can be readily determined. When it cannot, the lessee must use its incremental borrowing rate (IBR) (IFRS 16.26). In practice, the IBR becomes the default rate for most lessees, making it one of the most consequential judgements in lease accounting.

How IFRS 16 Discount Rate Works

Priority: implicit rate first. The lessee must first attempt to determine the IRIL — the rate that discounts lease payments and the unguaranteed residual value to equal the fair value of the underlying asset plus any initial direct costs of the lessor. Because lessees rarely have access to the lessor's residual value assumptions, the IRIL is seldom "readily determinable," and the IBR steps in as the practical default (IFRS 16.26).

IBR definition and key inputs. The IBR is the rate the lessee would pay to borrow funds — not a risk-free rate, not an equity return, but secured debt. It must reflect: (1) a term consistent with the lease term; (2) an amount equivalent to the right-of-use asset value; and (3) the lessee's own credit quality, currency, and economic environment at the commencement date. This is not a generic market rate — it is entity-specific and lease-specific.

Building the IBR in practice. A common constructive approach begins with an observable reference rate for the relevant currency and tenor (such as a government bond yield or interbank swap rate), then adds a credit spread reflecting the lessee's secured borrowing cost, and adjusts for jurisdiction or collateral differences. The IBR is fixed at the lease commencement date and is not updated simply because market rates move.

When floating rates change. Where lease payments are linked to floating interest rates and those rates change, a revised discount rate is required. IFRS 16.43 is explicit: the lessee shall use an unchanged discount rate unless the change in lease payments results from a change in floating interest rates, in which case a revised discount rate reflecting the change must be applied.

Reassessment triggers requiring a revised rate. A lessee must remeasure the lease liability using a revised discount rate when specific events occur — for example, a change in the lease term or a change in the assessment of a purchase option (IFRS 16.40). More broadly, after the commencement date, IFRS 16.36 governs how the lease liability carrying amount is updated to reflect interest, payments made, and any remeasurements from reassessments or modifications.

IFRS 16 Discount Rate — Common Pitfalls

Using a single company-wide IBR. The IBR must reflect the specific lease term, currency, and collateral of each arrangement. A single rate applied to all leases regardless of tenor or jurisdiction will almost certainly be incorrect.

Ignoring the secured nature of the rate. The IBR represents a secured borrowing rate — the lessee's unsecured bond yield is not an appropriate starting point without a downward adjustment for collateral.

Failing to update when required. While the IBR is generally locked in at commencement, lessees sometimes forget to apply a revised rate when IFRS 16.40 or IFRS 16.43 triggers a remeasurement.

Conflating the lessor's implicit rate with an IBR. For subleases, IFRS 16.68 permits an intermediate lessor, when the implicit rate in the sublease cannot be readily determined, to use the discount rate from the head lease (adjusted for initial direct costs). This is a lessor-specific rule and does not alter the lessee IBR hierarchy.

Misapplying the interest recognition pattern. Interest on the lease liability must produce a constant periodic rate of interest on the remaining balance — the effective interest method — using the rate from IFRS 16.26 (IFRS 16.37).

IFRS 16 Discount Rate — Key Paragraphs

IFRS 16.26 — Establishes the hierarchy: use the interest rate implicit in the lease if readily determinable; otherwise use the lessee's IBR. The foundational rule for discount rate selection.
IFRS 16.37 — Requires interest on the lease liability to be calculated using the effective interest method, producing a constant periodic rate on the remaining balance.
IFRS 16.40 — Triggers requiring a revised discount rate on remeasurement: change in lease term or change in assessment of a purchase option.
IFRS 16.43 — Specifies that the discount rate remains unchanged unless lease payments vary due to floating interest rate movements, in which case a revised rate must be used.
IFRS 16.36 — Governs subsequent measurement of the lease liability, including increases for interest, reductions for payments, and remeasurements from reassessments or modifications.
IFRS 16.68 — Permits an intermediate lessor to use the head lease discount rate (adjusted for initial direct costs) when the implicit rate in a sublease cannot be readily determined.