What is Borrowing Rate?
Borrowing Rate: The lease-specific discount rate used to determine the present value (NPV) of the lease payments. This is a required field in LeaseGuru.
How to determine the Borrowing Rate
ASC 842 recommends using the rate implicit in each lease as the borrowing rate to calculate the lease liability as this is the discount rate best representing the intended economics of the lease. However, the implicit rate is often not easily determined by the lessee. An entity’s incremental borrowing rate (IBR) can be used as an alternative to the implicit rate under ASC 842. If the rate implicit in the lease is not easily determined, a company can choose to apply their IBR.
The rate implicit in the lease is not usually readily determinable. Further, it can often be complex and even costly (if engaging an outside party) to estimate the incremental borrowing rate. In order to alleviate the burden of adopting ASC 842 for non-public entities, private entities are permitted by ASC 842 to apply a risk-free rate as the discount rate by class of underlying asset.
How do I find the borrowing rate in the lease contract?
At times, the lessor will include the rate implicit in the lease contract. If it is included, the implicit rate usually can be found with the payment schedule or summary of payments. It is common for vehicle or other equipment leases to include the rate the lessor is charging the lessee, but it will not be stated in all lease agreements.
What do I do if I can't find the borrowing rate/implicit rate in the lease contract?
If the lessor does not state the rate they are charging the lessee in the lease contract, first determine if the information to calculate the implicit rate (see the formula for calculating the implicit rate in the article) is available.
As the lessee, however, there can be complicating factors such as the lessee not being able to gather all the information that’s unique to a particular lease and needed to compute the rate the lessor is charging. In some instances, the lessor may be unwilling to share this information because it is the amount of profit they are making from the agreement. If the implicit rate is not stated in the lease or the information is not available to calculate it, the lessee is allowed to use their incremental borrowing rate (IBR).
Private entities have the additional option to apply a risk-free rate as the discount rate by class of underlying asset.
When do I reassess the discount rate for a lease?
Lessees do not have to reassess the discount rate annually. They are only required to reassess the discount rate if any of the following occurs:
- There is a change in the lease term
- There is a change in the assessment of whether the lessee is reasonably certain to exercise an option to purchase the underlying asset (if the lessee did not account for the option in the contract when determining the discount rate originally)
- A modification occurs (i.e., a change to the terms and conditions of the contract that results in a change in the scope of or the consideration for the lease) that is not accounted for as a separate contract.