As companies manage their lease portfolios, they often need to update their discount rates to perform accounting calculations for new leases and for existing leases that have been changed. This can be a time-consuming task for companies that have many leases. But with lease accounting software, it can be done quickly and efficiently.
A discount rate is used to calculate the balance of the lease liability, which is the discounted amount of the lessee’s financial obligation to make lease payments, otherwise known as the net present value. The lease liability must be recorded on the balance sheet. When it can be determined, ASC 842 requires lessees to use the discount rate implicit in the lease. But lessors rarely share the information needed to determine that. When the rate implicit in the lease is indeterminable – and it most often is – ASC 842 says lessees need to use the incremental borrowing rate (IBR) as the discount rate.
What is the IBR?
ASC 842 defines the incremental borrowing rate as “the rate of interest that a lessee would have to pay to borrowon a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment.” Lessees can obtain the IBR in a variety of ways, including from their bank, a valuation service, or their treasury department. To see one method of obtaining the IBR that has been used by several companies, read “A practical approach to the IBR for lease accounting.”
Using the IBR in Calculations
When companies begin a new lease or makes changes to an existing one, they typically need to obtain a new IBR. Changes to the lease that might require a new IBR include amendments, renewals, expansions, and lease concessions.
Companies with multiple locations often end up adding new leases or making changes to existing ones, requiring new IBRs. Collecting a new IBR every time a lease is added or changed can be a tedious and time-consuming process.
Automating the IBR
If many leases are changed and require a new IBR, accounting teams could spend hours inputting the new IBRs manually into a software program. This is risky as the more manual work is performed, the higher the margin for errors. One typo could become a material error on the balance sheet.
Errors can be avoided through automation within lease accounting software. All accounting teams need to do is periodically collect IBRs suitable for their company and categorize them into separate groups based on characteristics, such as length of lease term, location by country, type of currency, and type of asset like real estate or equipment. IBRs generally need to be updated monthly or quarterly, depending upon company policy, and uploaded into the software. That way, when there are new leases or changes to existing ones, the accounting software automatically inputs the correct IBR without any human intervention. Below is a simple example of an IBR chart for a company that leases assets in the U.S. and Canada with lease terms in five-year increments.
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