How to Calculate an Obtainable Borrowing Rate

Three inputs come straight from the lease document and drive everything after:

• The lease term. The non-cancellable period, plus any extension option you are reasonably certain to exercise, less any termination option you are reasonably certain to exercise. Judgement here changes the rate, because it changes the point on the yield curve you reference.
• The total undiscounted lease payments. The OBR definition references borrowing an amount similar to this figure, not the value of the asset. Sum the payments included in the liability.
• The security position on the borrowing. Not the security the lease carries, which the OBR definition does not mention, but what a lender would require to advance this sum: a debenture over the company's assets, a fixed charge over something the entity owns, a guarantee, or nothing at all. For most trading SMEs the honest answer is a debenture, because that is what a bank facility of this size normally carries.

Record the source of each. A reviewer will trace them back to the contract.

The base rate anchors the estimate to the market at the measurement date and is the part a reviewer can verify independently. For sterling obligations the usual reference is the SONIA term structure, matched to the lease term.

SONIA is generally preferred to gilt yields for this purpose because it reflects the rate at which banks actually fund themselves, which is closer to the basis on which they price commercial lending. A five year lease references the five year point; a two year lease references the two year point. Using a single overnight or base rate for every lease ignores the shape of the curve and is difficult to defend when rates across the term differ materially.

Whatever source you use, record the rate, the term, the date and where it came from.

The spread is the compensation a lender would require above the risk-free reference for lending to this borrower on these terms. It is where the entity-specific judgement sits, and where most of the audit attention falls.

A structured approach considers, at minimum:

• Financial strength. Leverage (total debt to EBITDA, debt to tangible net worth), interest and fixed charge cover, liquidity (current and quick ratios, cash buffer), profitability and margin stability, and cash generation. These are the ratios a credit committee actually looks at.
• Security and structure. Secured obligations price tighter than unsecured, because recovery in default is higher. The quality and enforceability of the security matters as much as its presence.
• Sector and size. Sector cyclicality and the resilience that comes with scale. A small enterprise carries less management depth, a narrower customer base and less access to alternative funding than a large one, and lenders price that.
• Exposure and concentration. The size of the obligation relative to the entity's balance sheet and cash generation.

Weighting these consistently is what makes rates comparable between leases, entities and periods. An unweighted judgement reached afresh each time will produce answers that cannot be reconciled to one another, which is precisely the criticism an auditor raises.

A single number presented with no range implies a precision that an estimate of this kind does not have. Producing a defensible range around the central rate, and stating why the central point was selected, is both more honest and easier to defend.

Useful sense checks:

• compare against the entity's actual borrowing cost, if it has any, adjusting for term and security differences;
• compare against any indicative rate the bank has given, recognising its limitations as evidence;
• test the direction of travel: a more leveraged entity, a longer term or an unsecured obligation should all push the rate up. If your method does not respond that way, it is not working.

The rate discounts the lease payments to give the lease liability, and the right-of-use asset follows from it.

There is a subtlety worth knowing. If your spread model considers exposure, meaning the size of the obligation relative to the entity, then the rate depends on the liability and the liability depends on the rate. The two have to be solved together rather than in one pass. Lease Rater iterates until the rate and the present value converge, and the report shows the iterations so the process is visible rather than assumed.

A five year equipment lease. Payments of £5,000 per month in advance, so total undiscounted payments of £300,000. The lessee is a profitable SME with moderate leverage, and on a facility of this size its bank would take a debenture over the business. Note that the security is the one the borrowing would carry: the leased equipment belongs to the lessor, so the lessee could not charge it to anyone.

• Base rate: five year SONIA reference at the measurement date, say 4.15%.
• Credit spread: assembled from the four factors above, say 250 basis points, reflecting satisfactory financial metrics and a debenture over the business.
• Obtainable borrowing rate: 4.15% + 2.50% = 6.65%.
• Defensible range: roughly 5.15% to 8.15%, with 6.65% selected as the central estimate.
• Lease liability: the present value of 60 monthly payments of £5,000 in advance at 6.65%, which is materially below the £300,000 undiscounted total. The difference is the finance charge recognised over the lease term.

The figures are illustrative. The structure is the point: an observable anchor, a stated spread, a range, and a liability that follows arithmetically from the rate.

Expect questions along these lines, and prepare the file to answer them without a meeting:

• Why could the implicit rate not be readily determined?
• Did you apply the incremental borrowing rate or the obtainable borrowing rate, and why?
• What is the base rate, at what date, from what source, and why that term?
• How was the credit spread derived, and what evidence supports it?
• Why is this entity's rate different from the rate used elsewhere in the group?
• Is the same method applied consistently across leases and periods?

None of these is difficult if the method was written down at the time. All of them are difficult if the rate was reached by judgement alone and documented afterwards.

Lease Rater performs every step above and produces the file behind it: the base rate and its source, the spread broken down by pillar with each pillar's contribution in basis points, the defensible range, the convergence iterations, and then the accounting that follows, being the present value, the amortisation and depreciation schedules, the journal templates and a disclosure note.

A calculation takes minutes rather than the two to four weeks of a bespoke study, and costs from £49 rather than £500 to £2,000. For a genuinely complex or highly material lease, a bespoke study remains the right answer; for a portfolio of routine leases before a year end, it is not practical.

Run one calculation free, or read how the OBR compares with the IBR before choosing which to apply.