Estimating Interest Rate for Leases - IFRS 16 Requirement (2024 Edition)

Description
IFRS 16 Requirements Based on IFRS 16.26, lease payments shall be discounted using the interest rate implicit in the lease, if that rate can be readily determined. If that rate cannot be determined, the lessee shall use the lessee's incremental borrowing rate ("IBR"). Based on defined terms in IFRS 16, IBR is the interest rate that a lessee would have to pay to borrow over a similar period. With similar security, the funds necessary to obtain an equal value to the right-of-use asset in a similar economic environment. Composition of the discount rate Based on the definition above, we believe a few factors need to be considered in determining IBR, namely: currency, term, asset type, economic environment. Based on the above, IBR will consist of 3 components: Risk-free rates, financing spread adjustment, and lessee specific adjustment. Risk-free rateWe use a risk-free rate as a starting point to compute IBR.Financing spread adjustment A yield spread over a risk-free rate can be determined by reference to credit rating agencies such as S&P, Moody's, and Fitch. However, in situations where the entity doesn't have a bond or credit rating, a synthetic rating for will be estimated. In determining the link between interest coverage ratios and ratings, all rated companies in the United States were referenced. The default spreads are obtained from traded bonds.A large majority of corporations borrow on an "unsecured" basis. One approach from Bloomberg (+1 for Ba3/BB- or higher and +2 for B1/B+ or lower) is very similar and broadly in line with Moody's notching methodology. Applying the "notching" is a viable workaround to determine a borrowing "proxy" for a secured rate in cases where observable data is scarce. As the published referenced synthetics ratings were derived from the United States, an additional country-risk premium would be added for all ex-United States leases. The country-risk premium, therefore, considers the economic environment where lease asset locates.