OBR vs IBR Under FRS 102

FRS 102 para 20.49 provides that where the implicit rate cannot be readily determined, the lessee applies either its incremental borrowing rate or its obtainable borrowing rate. Both are permitted. Neither is a fallback from the other.

The choice is available on a lease-by-lease basis, so an entity is not locked into one approach across its whole portfolio, although there are good reasons for consistency which we come to below.

Both rates ask what the entity would pay to borrow. They differ in what is being borrowed.

The two reference amounts are not the same figure, and the gap is not trivial.

The right-of-use asset is measured at the present value of the lease payments plus certain costs. The total undiscounted lease payments are, by definition, larger, because they include the finance element spread across the term. On a five year lease at a mid single digit rate, the undiscounted total might exceed the discounted asset value by something in the order of fifteen per cent.

So the OBR references a somewhat larger notional borrowing than the IBR for the same lease. Whether that changes the rate depends on how sensitive lending margins are to loan size in the relevant range. For most SME facilities the answer is: not much. Between, say, £250,000 and £300,000 a lender is unlikely to price differently.

This is why you will see it said that the two rates are "the same in practice". That is a reasonable working generalisation, not a rule. It holds where pricing is insensitive to size over the relevant range, and is weaker where a size threshold sits between the two figures, or where the entity's borrowing capacity is constrained enough that a larger notional facility genuinely prices wider.

This, rather than the arithmetic, is usually the deciding factor.

The OBR references the total undiscounted lease payments, which is a figure already stated in, or directly calculable from, the lease. You can point at it.

The IBR references the value of a similar asset. That is one more thing to establish: what the asset is worth, on what basis, at what date, supported by what evidence. For a property lease in particular, establishing the value of a similar asset is a valuation exercise in itself.

The FRC introduced the OBR deliberately as the more practicable option for entities applying FRS 102, many of which do not have treasury functions or established borrowing benchmarks. Choosing it is not a shortcut; it is using the option designed for the circumstances.

The OBR suits most SME situations, but not all. Consider the IBR where:

• the entity already calculates an IBR for IFRS 16 purposes elsewhere in the group, and consistency across the group's reporting is worth more than simplicity in one entity;
• there is a recent, genuinely comparable borrowing that supports an IBR directly, making it the better evidenced of the two; or
• the asset value is readily available and well supported, and the lease is material enough to justify the additional work.

The point is not that one rate is correct. It is that the choice should be made deliberately and recorded, rather than arrived at by default.

Although the choice is available lease by lease, switching between approaches without reason invites questions. Two leases with similar terms and security producing materially different rates because different methods were used is difficult to explain, and harder still in a later period when the person who chose has moved on.

A sensible position for most entities is to adopt one approach as the default, apply it consistently, and document the specific reasons wherever a different approach is taken for a particular lease. Section 20 requires disclosure of information about discount rates, and an entity that has made a clear policy choice has a straightforward disclosure to write.

1. Can the implicit rate be readily determined? If yes, use it; the choice below does not arise. For most SME leases it cannot, because it depends on the lessor's costs and residual assumptions.
2. Do you already have a supportable IBR from group reporting or a recent comparable borrowing? If so, using it may be both easier and more consistent.
3. If not, the OBR is usually the more practicable option, because its reference amount is already in the lease.
4. Whichever you choose, document it: which rate, why, the base rate and its source, and how the credit spread was derived.

Lease Rater produces an obtainable borrowing rate, because that is the option most FRS 102 entities will reasonably take and the one whose inputs are easiest to evidence. It does not suggest that an IBR approach is wrong where management considers it more suitable.

Each report states the base rate and its source, the credit spread broken down by pillar, with each pillar's contribution in basis points, a defensible range, and then the accounting that follows: present value, amortisation and right-of-use depreciation schedules, journal templates and a disclosure note. That is the material an auditor asks for, prepared at the time rather than reconstructed afterwards.

Run one calculation free, or read how the rate is built step by step.