Incremental Borrowing Rate (IBR): the interest rate all lessees are able to use when the implicit rate is not readily available or able to be calculated.
The glossary of ASC 842 defines the incremental borrowing rate as the rate of interest a lessee would have to pay to borrow an amount equal to the total lease payments on a collateralized basis over a similar term in a similar economic environment. Think about this as the rate charged by your bank or financial lender to borrow an amount of money equal to the total lease payments over the lease term.
Note: this definition differs from ASC 840, which defined this rate as the rate the lessee would have incurred to borrow over a similar term the funds necessary to purchase the leased asset.
The incremental borrowing rate is calculated based on factors specific to the company and the contract such as credit rating, the underlying asset, the lease term, and the economic environment. It can be difficult and expensive to obtain IBRs for the various leases in an entity’s portfolio, especially for non-public entities that may not have information like comparable credit spreads readily available.
In cases where a company’s treasury department is not equipped to establish these rates, organizations may choose to engage with external firms that specialize in valuations, third party lenders, or other parties to get an accurate estimation of an IBR. This can significantly increase the cost associated with compliance with ASC 842. No matter the method an entity uses to determine their IBR for their leases, it is important to document the method, reasoning, and overall findings and discuss the conclusions with the external auditors.