FRS 102 Discount Rate: OBR, IBR, Implicit
The discount rate is the single input with the largest effect on your lease liability, and the one an auditor is most likely to ask you to justify. FRS 102 names three rates, and for most UK SMEs the obtainable borrowing rate is both permitted and far easier to evidence.
The order FRS 102 sets
FRS 102.20.49 asks one question first: can the rate implicit in the lease be readily determined? If it can, use it. If it cannot, you choose, lease by lease, between the incremental borrowing rate and the obtainable borrowing rate. The standard does not rank those two, and neither is restricted by entity type.
FRS 102 Reference: FRS 102.20.49
| Step | Rate | What it is | In practice |
|---|---|---|---|
| 1 | Rate implicit in the lease | The rate at which the present value of the lease payments and the unguaranteed residual value equals the fair value of the asset plus the lessor's initial direct costs | Rarely determinable: it needs the lessor's cost base and residual value assumption |
| 2, either | Incremental borrowing rate (IBR) | What you would pay to borrow, over a similar term and with similar security, the funds to obtain a similar asset in a similar economic environment | More judgemental; usually derived by adjusting an existing facility rate |
| 2, or | Obtainable borrowing rate (OBR) | What you would pay to borrow the funds necessary to make the total of all payments under the lease | The SME simplification, and what most Lease102 users apply |
When the implicit rate is actually available
It is worth checking before you fall back on a borrowing rate, because in a few common cases the implicit rate is genuinely determinable: hire-purchase agreements where the cash price and the payment schedule are both known, leases where the lessor has disclosed the rate, and vehicle agreements where the manufacturer's list price is a reasonable proxy for fair value.
IBR against OBR
The two are often confused. The difference is what you are assumed to be borrowing and against what security. OBR is deliberately the simpler question, which is why it exists.
The choice is yours, lease by lease
| Factor | IBR | OBR |
|---|---|---|
| Amount assumed borrowed | An amount equal to the right-of-use asset value | The total of the lease payments |
| Security assumed | Similar to the leased asset | General borrowing |
| Judgement required | More | Less |
| Who may use it | Any lessee, chosen lease by lease | Any lessee, chosen lease by lease |
Building an OBR you can evidence
Lease102 derives the OBR from a live reference rate plus a credit spread, which gives you a rate that is defensible because both halves are traceable. SONIA is used for sterling leases and the euro short-term rate for euro leases. Both are refreshed on the days that can actually move them, in the days following a Bank Rate decision and following a transition date, and at least twice a month regardless, so a rate is never quietly weeks out of date.
FRS 102 Reference: FRS 102.20.49
OBR build-up
Credit spreads
The spread reflects your entity's credit standing. Pick the profile that matches the evidence you hold, not the one that produces the answer you want: the rate is a disclosure item and the direction of the bias is obvious to a reviewer.
| Profile | Spread | Illustrative OBR at 4.50% SONIA |
|---|---|---|
| Strong | +1.25% | ~5.75% |
| Average SME | +2.25% | ~6.75% |
| Higher risk | +3.50% | ~8.00% |
Other evidence an auditor will accept
A reference rate plus a spread is one route. Others are equally acceptable and sometimes stronger, particularly where the entity actually borrows.
Your existing bank facility rate
Often the most defensible source for an SME that already borrows, since it is what the entity demonstrably pays.
A recent loan offer or bank quote
Useful where the entity has no current borrowing. Keep the quote with the lease file.
Published rates on new lending to SMEs
The Bank of England publishes effective rates on new loans to small and medium-sized businesses, which is a reasonable external benchmark where nothing entity-specific exists.
Set the rate per lease, not once for the portfolio
The rate belongs to the individual lease, not to the folder it sits in. Two leases in the same portfolio can properly carry different rates, because each is measured on the day that governs it. Lease102 lets a portfolio suggest a default rate, but each lease keeps its own, and the rate type recorded against it (OBR, IBR or implicit) feeds the disclosure that reports which types you used and in what proportion. Which day governs a given lease is not always its commencement date, and the next section sets out how that is decided.
Document the basis, not just the number
Which day's rate applies, and why a 2019 tenancy does not need a 2019 rate
Every rate belongs to one particular day, and Lease102 works out which day before it offers you a rate. A lease that was already running when the new rules start for you is measured at the rate for the date of initial application, whatever year it began: a tenancy signed in 2019 uses the rate for your changeover date, not a 2019 rate. A lease commencing after that date uses the rate on its own commencement date. A lease that was already on your balance sheet as a finance lease keeps its existing figures and needs no new rate at all.
FRS 102 Reference: FRS 102.1.51(a), 20.49, 1.55
| Lease | Rate it uses |
|---|---|
| Already running at your changeover date | The rate for the changeover date |
| Commences after your changeover date | The rate on its own commencement date |
| Previously held as a finance lease | None: existing figures carry across |
| Rate implicit in the lease, or an incremental borrowing rate | Entered by hand, not fetched |
Provisional rates, and confirming them on the day
The reference rate for a given day is published the following working day, so a rate for a date still in the future cannot be known yet. Where that is the case Lease102 offers the latest published rate, labels it provisional, and records the day it was actually taken for. You can carry on loading leases; nothing is silently treated as final. When you run Bulk Calculate on or after your changeover date, any lease still holding a provisional rate is listed, and you either take the published rate for that day or confirm you want to keep the one you have.
Run the transition a few days after the date, not on it
Bank Rate decisions before your changeover date
The Bank of England changes Bank Rate only on scheduled announcement dates, eight times a year, at noon on a Thursday. Between those dates the reference rate barely moves. Where a decision falls between today and the date that governs a lease, Lease102 names it, so you know whether a provisional rate is likely to change before it is confirmed. If none does, the rate you are shown now is very probably the rate you will confirm. The Bank publishes the next year's dates around each December and marks the further year provisional, so the list can only ever reach about eighteen months ahead: for a date beyond it Lease102 says the list does not run that far rather than telling you nothing is due. An unscheduled decision, which the Committee can hold in exceptional circumstances, is on no calendar at all, which is why the rate is confirmed against the published rate rather than against these dates.
If a published rate later differs from the one used
Once the rate for a governing day is published, Lease102 compares it against what the lease was actually priced at and reports any case where the two differ. This covers both kinds of lease: a transitioned lease is checked against the rate for the changeover date, and a lease measured from its commencement date, for example one loaded before it started, is checked against the rate for that day. Nothing is repriced automatically, because the figures may already have been reported. A transitioned lease is repriced with one deliberate Recalculate on the Transition screen; a lease measured from commencement is corrected by editing its rate, which re-measures it from the start, the right answer for correcting initial measurement. Where the rate did not move, which is the usual case, you are told nothing.
What happens when rates change later
A change in market rates does not, by itself, cause you to revisit an existing lease. The rate is revisited on a reassessment or a modification, and even then not always: some changes keep the original rate and some require a revised one. See the lease modifications topic for which is which.