IFRS 16 · ASC 842 · GASB 87
Understanding the Interest Rate Implicit in a Lease
ASC 842, IFRS 16, and GASB 87 all require a lessee to discount future lease payments to present value when recognising a lease liability — and all three put the rate the lessor charges in the lease at the top of the discount-rate hierarchy. That rate is the interest rate implicit in the lease.
1What is the implicit interest rate?
Conceptually, the implicit rate is the lessor’s internal rate of return on the lease: the single discount rate at which everything the lessor expects to receive equals everything the lessor has invested in the asset at commencement.
IFRS 16 · Appendix A
IFRS 16 (Appendix A) defines it as the rate that causes the present value of (a) the lease payments and (b) the unguaranteed residual value to equal the sum of (i) the fair value of the underlying asset and (ii) any initial direct costs of the lessor. The ASC 842 glossary definition is essentially the same, and additionally deducts any investment tax credits retained and expected to be realised by the lessor.
Because it is an internal rate of return, there is no closed-form formula — the rate is found iteratively (this calculator uses a numerical solver, the same way a spreadsheet IRR or RATE function would).
2What each standard says
The three lease standards share the same hierarchy: use the rate in the lease when you can; fall back to your own borrowing rate when you cannot.
IFRS 16 (paragraph 26): the lessee discounts lease payments at the interest rate implicit in the lease if that rate can be readily determined; otherwise at the lessee’s incremental borrowing rate.
ASC 842 (842-20-30-3): same principle — implicit rate when readily determinable, otherwise the incremental borrowing rate. Entities that are not public business entities may instead elect, by class of underlying asset, to use a risk-free rate.
GASB 87 (paragraph 23): the lessee uses the interest rate the lessor charges — which may be the implicit rate — and, if that rate cannot be readily determined, the lessee’s own incremental borrowing rate.
3Why lessees can rarely determine it
The lessor always knows the implicit rate, because the lessor set the terms. The lessee usually cannot reproduce it exactly: the definition depends on lessor-side inputs the lessee rarely sees — the lessor’s initial direct costs, the lessor’s estimate of the unguaranteed residual value, and (under ASC 842) investment tax credits the lessor retains. That is why, in practice, most lessees conclude the implicit rate is not readily determinable and use their incremental borrowing rate instead.
4How this calculator helps
This tool solves the rate from the inputs a lessee can observe: the fair value being financed, the payment amount, frequency and timing, and any residual or buyout value. The result is the rate at which those cash flows discount back to the fair value — a close, observable approximation of the rate you are actually being charged.
Use it to sanity-check a quoted lease against your borrowing alternatives, or to estimate the lessor’s pricing. If the true implicit rate is not readily determinable for accounting purposes, the standards direct you to your incremental borrowing rate — the result here does not replace that assessment.