Companies should not underestimate the time it will take to determine appropriate incremental borrowing rates. lessee-specific features or factors should be reasonably considered in the assessment of the rates.
Incremental borrowing rate is defined under HKFRS 16 as the rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment.
In real life, the rates cannot be directly obtained for many leases such as operating leases of office and retail shops. In such cases, the right-of-use assets for a specific period are not common collateral of commercial loans. It is not common for banks to provide financing with such right-of-use assets as collateral, making direct reference of interest rate in such financing scheme unfeasible.
Using General Borrowing Rate or Property Yield as Starting Point
Based on its own facts and circumstances, a company should usually consider applying the following adjustments to its general borrowing rate as needed:
- Align the duration of the loan to the length of the lease;
- Reflect the loan with a collateral similar to the nature and quality of the leased asset;
- Reflect the loan amount similar to the value to the right-of-use asset; and
- Align the currency of the loan with the currency of the lease payments.
Alternatively, property yields (or rental yields) of the leased assets can be used as a starting point to derive incremental borrowing rates.
In both cases, a systematic process to derive applicable company specific adjustment factors should be in place to determine incremental borrowing rates.
Many listed companies may be lack of necessary third-party data and a systematic process to determine incremental borrowing rates.
Valtech has been helping our clients for smooth application and compliance of treatment according to the requirements of HKFRS 16.