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Specific considerations for subsidiaries and the portfolio approach
We discuss the consideration to the incremental borrowing rate for a subsidiary and the application of the portfolio approach under IFRS 16.
This set of five EY IFRS podcasts on the determination of discount rates by lessees, when applying the new leases standard of IFRS 16 Leases is presented by Victor Chan and Luci Wright from EY’s Global IFRS team.
When a lessee applies IFRS 16, it must determine the discount rate to apply to the lease payments. In this episode, we discuss the considerations in determining the incremental borrowing rate for a subsidiary. We will also discuss the application of the portfolio approach under IFRS 16.
Learning outcomes
Factors to consider when determining the incremental borrowing rate for a subsidiary.
What to consider if applying a portfolio approach under IFRS 16.
For your convenience, full text transcript of this podcast is also available.
Luci Wright
Welcome to the third episode of this series of EY podcasts on the determination of discount rates by lessees when applying the new leases standard of IFRS 16. I am Luci Wright, an Executive Director with EY Global IFRS Services in London. In this episode, we would discuss the specific consideration to the incremental borrowing rate for a subsidiary and the application of the portfolio approach under IFRS 16. Today I am joined by Victor Chan, a partner with EY Global IFRS Services and a member of EY Global Subject Matter Group on leases. Victor, welcome to our podcast.
Victor Chan
I am glad to be here.
Wright
When a subsidiary enters into a lease arrangement, should the incremental borrowing rate of the subsidiary or the parent be used to measure the lease liability in the parent’s consolidated financial statements? And should the incremental borrowing rate used to measure the lease liability in the subsidiary’s standalone financial statements be the same as that used in the parent’s consolidated financial statements?
Chan
When a subsidiary enters into a lease arrangement, the incremental borrowing rate of the subsidiary should be used to measure the lease liability in the parent’s consolidated financial statements. This means that the same incremental borrowing rate is used in both the subsidiary’s standalone financial statements if the subsidiary prepares its own financial statements under IFRS, and the parent’s consolidated financial statements. It is worth mentioning that the incremental borrowing rate, by definition, takes into account the security provided and hence guarantees. Thus, if the parent provides explicit or implicit guarantees on the subsidiary’s lease payments, this should be reflected in the determination of the incremental borrowing rate
Wright
Often large companies have centralised treasury functions for their entities within the group and thus a subsidiary within the group relies on funding from the group’s treasury internally and won’t have any financing arrangements with third parties. In these situations, can a subsidiary use the parent’s incremental borrowing rate?
Chan
The definition of the incremental borrowing rate is lease specific and depends on the credit profile of the lessee. If a lease is entered into by a subsidiary, then the incremental borrowing rate of the subsidiary should be used, taking into account the security provided in the contract. Without any explicit or implicit guarantees from the parent, the incremental borrowing rate of a subsidiary may be different from that of the parent. The incremental borrowing rate of the parent may be used as a starting point but adjustments, especially related to the different credit profiles, may be necessary.
Wright
This means that the inter-company borrowing rate or a deemed interest rate for transfer pricing purposes may not represent the incremental borrowing rate as specified under IFRS 16.
Chan
That’s right, Luci.
Wright
For lessees with, say, thousands of leases, evaluating the incremental borrowing rate for each and every lease could be rather complex. Is there any practical expedient a lessee can elect under IFRS 16 to make it easier to apply the standard?
Chan
Yes, Luci. IFRS 16 includes a practical expedient, which allows a lessee to apply the standard to a portfolio of leases with similar characteristics if the lessee reasonably expects that the effects on the financial statements of applying the standard to the portfolio would not be materially different from applying the standard to the individual leases within that portfolio. If accounting for a portfolio, a lessee is required to use the estimates and assumptions that reflect the size and composition of the portfolio. In addition, a lessor may also elect to adopt this practical expedient.
Wright
Thanks again for sharing your insights with us, Victor. In the next episode, we will consider the currency used in the determination of the incremental borrowing rate.
