Key Takeaways
- FRS 102 calls it the "obtainable borrowing rate" (OBR). It's the same concept as IFRS 16's incremental borrowing rate (IBR)
- The most practical approach for UK entities is: Swap Rate + Credit Spread
- Swap rates are preferred over government bonds as the risk-free base because they better reflect corporate borrowing costs
- If you don't have a credit rating, estimate your credit spread from a bank loan quote or financial ratio benchmarks
- Fix your credit spread for 12–24 months and update the base rate curve periodically for new leases
Why Discount Rates Are a Challenge for FRS 102 Entities
Under the revised Section 20, every lease liability must be measured at the present value of future lease payments. The discount rate you use directly affects the size of the liability on your balance sheet and the interest expense in your income statement.
For larger entities reporting under IFRS 16, this is familiar territory. They've been doing it since 2019 and typically have treasury teams, existing bank facilities, and sometimes credit ratings to draw on.
Most FRS 102 entities don't have these advantages. They are private companies, often without public debt, credit ratings, or dedicated treasury functions. Many are encountering on-balance-sheet lease accounting for the first time. This guide provides a practical, step-by-step approach to determining the discount rate that works for these entities.
What Is the Obtainable Borrowing Rate?
FRS 102 Definition
"The interest rate a lessee would have to pay to borrow, over a similar term and with similar security, the funds needed to purchase a comparable asset in a similar economic environment."
- FRS 102, Section 20
In plain terms: if you were to walk into a bank and ask for a secured loan to buy the asset you're leasing, with the same repayment term as the lease, what interest rate would they charge you?
The OBR is the fallback rate when the interest rate implicit in the lease isn't available, which is the case for the vast majority of leases, since lessees typically don't have access to the lessor's cost and residual value assumptions.
OBR vs IBR: Same Concept, Different Name
IFRS 16 calls this the "incremental borrowing rate" (IBR). The definition and practical determination are identical. If your group has already determined IBRs for IFRS 16 purposes, the same methodology applies. The rate is entity-specific, so a subsidiary's OBR may differ from the group's IBR.
The Rate Hierarchy
FRS 102 establishes a clear order of preference:
Interest Rate Implicit in the Lease
Use this if it can be readily determined. This is the rate that causes the present value of lease payments plus the unguaranteed residual value to equal the fair value of the underlying asset. In practice, this is only available when the lessor discloses it (e.g. some motor vehicle finance leases).
Obtainable Borrowing Rate (OBR)
When the implicit rate isn't available (the usual case), determine your own OBR. This is where the rest of this guide focuses.
The OBR Formula
The most practical and widely accepted approach to determining the OBR is to build it up from two components:
| Component | What It Represents | Source |
|---|---|---|
| Swap rate | The risk-free base rate for the relevant term | GBP interest rate swap curve (publicly available) |
| Credit spread | The premium a lender charges for your credit risk | Bank quote, financial ratios, or market data |
This approach assumes secured borrowing, which is appropriate because leases are economically similar to secured debt, with the underlying asset providing security to the lessor.
Why Swap Rates, Not Government Bonds
Many IFRS 16 implementations use government bond yields (UK gilts) as the risk-free rate. For FRS 102 entities, swap rates are a better starting point:
| Factor | Government Bonds (Gilts) | Swap Rates |
|---|---|---|
| Reflects | Government borrowing costs | Interbank lending costs |
| Relevance to corporates | Indirect. Requires larger credit spread adjustment | More direct. Closer to what banks use for pricing |
| Maturity coverage | Standard maturities only (2, 5, 10, 30 year) | Continuous curve across all maturities |
| Policy distortion | Affected by quantitative easing and government debt management | Less distorted by monetary policy |
| Practitioner acceptance | Widely used, fully acceptable | Increasingly preferred by auditors |
Both approaches are acceptable. Government bonds require a larger credit spread to reach the same OBR, while swap rates start closer to the final rate. The key is consistency: choose one approach and apply it across your lease portfolio.
Where to Find GBP Swap Rates
GBP interest rate swap rates are published daily by the Bank of England (SONIA-linked) and by major financial data providers. Your auditor or bank can also provide current rates for specific tenors.
Determining Your Credit Spread
The credit spread is the premium a lender charges above the base rate to compensate for the risk of lending to your company. Most FRS 102 entities don't have a public credit rating, so you need to estimate this spread. There are two practical approaches.
Method A: Bank Loan Quote (Recommended)
The most straightforward approach is to ask your bank for an indicative rate on a secured loan of a similar term and amount to the lease. Then back out the credit spread:
Worked Example: Bank Quote Method
Your bank offers a 5-year secured loan at 5.80%. The 5-year GBP swap rate is 3.20%.
| Input | Value | Source |
|---|---|---|
| Bank loan rate (5-year secured) | 5.80% | Indicative quote from bank |
| GBP swap rate (5-year) | 3.20% | Bank of England / market data |
| Implied credit spread | 2.60% |
Once you have your credit spread, you can apply it across other maturities by adding it to the corresponding swap rate. For example, a 3-year lease would use the 3-year swap rate + 2.60%, and a 7-year lease would use the 7-year swap rate + 2.60%.
Getting the Quote
You don't need to actually take out the loan. Contact your relationship manager and ask: "What rate would you offer for a [5-year] secured term loan of approximately [£X]?" This gives you a market-based data point that auditors are comfortable with.
Method B: Financial Ratio Benchmarks
If you don't have a bank relationship or recent loan quote, you can estimate your credit spread by mapping your financial ratios to an implied credit rating. This requires three inputs from your latest financial statements:
| Ratio | Formula | What It Shows |
|---|---|---|
| Interest coverage | EBIT ÷ Interest expense | How easily you can service debt |
| Debt-to-equity | Total debt ÷ Equity | How leveraged the business is |
| EBITDA margin | EBITDA ÷ Revenue | Your profitability cushion |
Compare these ratios against industry benchmarks to determine an implied credit rating, then apply the corresponding credit spread:
| Implied Rating | Interest Coverage | Debt / Equity | EBITDA Margin | Typical Spread |
|---|---|---|---|---|
| AA | More than 8x | Less than 0.5 | More than 25% | 1.0% |
| A | 4–8x | 0.5–1.0 | 20–25% | 1.5% |
| BBB | 2–4x | 1.0–2.0 | 15–20% | 2.0% |
| BB | 1–2x | 2.0–3.0 | 10–15% | 3.0% |
| B | Less than 1x | More than 3.0 | Less than 10% | 5.0% |
Indicative spreads for secured borrowing. Actual spreads vary by industry, economic conditions, and specific circumstances.
Use Judgement
These benchmarks are indicative, not prescriptive. A company may have strong interest coverage but high leverage. In that case, lean towards the higher spread. Where your ratios span multiple categories, take the middle ground and document your reasoning. The important thing is that your approach is reasonable and consistently applied.
Worked Example: Full OBR Calculation
Scenario
A UK private company enters into a 7-year office lease on 1 April 2026 with annual payments of £50,000. The company has no credit rating. Their bank has quoted 6.00% for a 7-year secured loan. The 7-year GBP swap rate on the commencement date is 3.40%.
Step 1: Determine the Credit Spread
| Input | Value |
|---|---|
| Bank loan rate (7-year secured) | 6.00% |
| GBP swap rate (7-year) | 3.40% |
| Credit spread | 2.60% |
Step 2: Calculate the OBR
| Component | Rate |
|---|---|
| 7-year GBP swap rate | 3.40% |
| Credit spread | 2.60% |
| Obtainable borrowing rate | 6.00% |
Step 3: Calculate the Lease Liability
Using the 6.00% OBR, the present value of 7 annual payments of £50,000 gives a lease liability of approximately £279,300 at commencement.
Step 4: Validate
Cross-check the rate against available reference points:
- The bank quote directly supports the 6.00% rate
- The company's financial ratios suggest a BBB implied rating (interest coverage 3.2x, debt/equity 1.4, EBITDA margin 18%), which maps to a 2.0% spread, close to the 2.60% derived from the bank quote
- The bank quote is slightly higher, which is expected since it reflects a specific assessment rather than a benchmark
The 6.00% OBR is reasonable and well-supported.
Using a Portfolio Rate
FRS 102 explicitly permits applying a single discount rate to a portfolio of leases with reasonably similar characteristics, provided it wouldn't result in a materially different outcome from applying rates individually.
This is particularly useful for FRS 102 entities with multiple leases of the same type, for example a fleet of vehicles or several office leases with similar terms.
Defining Your Portfolios
Group leases by the characteristics that affect the discount rate:
For detailed guidance on defining portfolios, see the IFRS 16 discount rates guide. The same principles apply.
Ongoing Rate Management
Once you've established your OBR methodology, you need a practical policy for maintaining rates over time. The most common approach:
Fix the Credit Spread
Review and set your credit spread once every 12–24 months, or when your risk profile changes materially (e.g. a significant new borrowing facility, major change in profitability, or restructuring). Between reviews, hold it constant.
Update the Base Rate Curve
Update the swap rate curve monthly or quarterly so that new leases commencing in different periods reflect current market conditions. This ensures your OBRs remain market-based without requiring a full reassessment each time.
Lock Rates at Commencement
Once a lease commences, its discount rate is locked. It only changes for specific remeasurement events such as a change in the assessed lease term or a lease modification.
This gives you the benefit of market-based rates without the overhead of recalculating your credit spread for every lease.
When the Discount Rate Changes
The OBR is set at lease commencement. It is only revised when specific events occur:
| Event | Revised Rate? |
|---|---|
| Change in assessed lease term (e.g. exercising an extension option) | Yes. New rate at remeasurement date |
| Lease modification that is not a separate lease | Yes. New rate at modification date |
| Change in purchase option assessment | Yes. New rate at remeasurement date |
| Change in index-linked or CPI-linked payments | No. Use original rate |
| General market interest rate movements | No. Rate is locked at commencement |
| Change in the entity's credit profile | No. Only affects rates for new leases |
For detailed guidance on remeasurement triggers and calculations, see our IFRS 16 remeasurement guide.
Documentation and Audit Readiness
Discount rate determination is one of the most scrutinised areas in lease accounting audits. Whatever method you use, document it clearly.
What to Document
Auditor Expectations
Auditors will challenge discount rates, particularly where the rate has a material effect on the lease liability. Having a clear, documented methodology with verifiable inputs significantly reduces audit friction. Don't wait until the audit. Prepare your rate file when you set the rates.
Discount Rates at Transition
For the initial adoption of the revised Section 20, you need to determine a discount rate for each existing lease. If you're using the simplified (modified retrospective) transition approach, you have a choice:
- Use the OBR at the date of initial application: a current rate, which is simpler because you only need one rate assessment per portfolio
- Use the OBR that would have applied at lease commencement: a historical rate, which gives a more accurate liability but requires sourcing historical market data
Most entities using the simplified approach will apply current rates at transition, grouping leases into portfolios by remaining term to reduce the number of rates needed.
For a detailed walkthrough of the transition process, see our FRS 102 Transition Guide.
This article is provided for general informational purposes only and does not constitute accounting, legal or professional advice.