United Arab Emirates: CFO's Guide: Discount Rates (Video)

Last Updated: 27 June 2019
Article by Blaise Jenner

In this series we have previously explored the key IFRS 16 headlines, which groups will be most impacted by the new standard and how groups should be preparing for transition to IFRS 16. Building on the previous articles, we shall continue to consider key areas of analysis and judgment that should be considered as part of any IFRS 16 implementation exercise. In this article we focus in the importance and relevance of discount rates in the IFRS 16 calculation.

Discount rates

A key principle of IFRS 16 is that leases are now brought 'on balance sheet' for lessees and effectively viewed as a source of financing to the company. As part of reflecting this financing nature of the arrangement, the discount rate applied to the lease is therefore relevant in order to calculate both the discounted day one lease liability and the future interest costs on the lease arrangement. This can bring complexity for groups who have not previously been required to derive such discount rates for their operating leases and will also require potentially different rates for leases depending on a number of variable factors. In the below video our global IFRS 16 team considers some of the following key questions:

  • What are the IFRS 16 requirements for discount rates and what approach are we practically seeing clients apply?
  • What potential approaches can be applied in identifying an appropriate discount rate?
  • What are the key factors and variables to consider in deriving discount rates?
  • What does this mean for IFRS 16 implementation projects - especially for those groups with a large number of leases?

Key takeaways for the Middle East CFO

For both implementing and embedding IFRS 16, groups will now need to develop an appropriate IFRS 16 discount rate framework for leases. This is a new requirement for groups and driven by the overiding concept of leases being brought on balance sheet under IFRS 16 and viewed as a source of financing to the group. As part of this, groups should consider:

  • Practically we see that many groups do not have access to the 'rate implicit in the lease' and therefore base their discount rates in the 'incremental borrowing rate' (IBR) approach;
  • IFRS 16 does not specify how to calculate the IBR and we have seen different approaches being applied by clients - including adjusted risk free rates; and adjusted lessee actual borrowing rates;
  • From the above two approaches we would expect to see relevant adjustments made based on the lease term, security, value and economic environment of the lease;
  • In developing the discount rate framework, groups can consider how certain categories or groups of assets can be grouped together - the intention of the standard is not to require unique discount rates for each and every lease but to create a consistent methodology to estimate the IBR.

29 Nov 2018

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