What is the meaning of incremental borrowing rate?

Incremental borrowing rate represents the interest rate a lessee would pay to borrow funds on a collateralized basis over a similar term for an amount equal to lease payments in a comparable economic environment. This rate serves as the discount rate for present value calculations when the lessor&#8

What is the meaning of borrowing rate?

A borrowing rate represents the interest rate a borrower pays on a loan, expressing the cost of borrowing money as a percentage of the principal amount. This rate can also be called an interest rate and reflects factors like the borrower’s creditworthiness, loan term, and prevailing market con

What is the difference between incremental borrowing rate and implicit rate?

Incremental borrowing rate focuses on what the lessee would pay to borrow similar amounts, while the implicit rate reflects the lessor’s expected return on the leased asset investment. Although lessees can rarely calculate the implicit rate due to limited information about the lessor’s c

Is IBR the same as discount rate?

The incremental borrowing rate essentially functions as the discount rate for lease accounting purposes when determining present value of lease payments. Since lessees almost never know the lessor’s implicit rate in arm’s length transactions, IBR becomes the practical discount rate used

How often should companies reassess their IBR?

Companies typically determine IBR at lease commencement and maintain that rate throughout the lease term unless significant modifications occur. Minor market fluctuations or temporary credit changes do not require IBR adjustments, as consistency in application provides more reliable financial report

What documentation supports IBR calculations?

Effective IBR documentation includes current credit agreements, recent borrowing transactions, credit rating information, and relevant market data from the measurement date. Companies should maintain clear explanations of their methodology, adjustment factors applied, and sources of market informati

Can companies use portfolio approaches for IBR?

ASC 842 permits portfolio approaches that apply consistent IBR rates across leases with similar characteristics, terms, and economic environments. This practical expedient reduces administrative burden while maintaining accuracy for comparable lease arrangements. Companies must establish clear crite

How does credit rating affect IBR determination?

Credit ratings significantly influence IBR calculations by establishing the baseline risk premium above risk-free rates. Companies with higher credit ratings typically determine lower incremental borrowing rates, while organizations with credit challenges must incorporate higher risk premiums. Curre

What market factors influence IBR calculations?

Market interest rates, credit spreads, and economic conditions at lease commencement all impact IBR determination. Companies must consider Treasury rates, corporate bond yields, and banking market conditions specific to their industry and credit profile. Similar to how Market conditions influence bu

Do lease terms affect IBR selection?

Lease terms directly influence IBR determination since the borrowing rate must match the lease duration for accurate present value calculations. Longer lease terms typically require higher rates due to increased duration risk, while shorter terms may benefit from lower rates reflecting reduced expos

How do secured versus unsecured borrowings impact IBR?

Lease accounting assumes collateralized borrowing for IBR calculations, requiring companies to estimate secured borrowing rates even if they typically use unsecured financing. Organizations must consider what assets they would pledge as collateral and how that security would affect their borrowing c

What role do valuation professionals play in IBR determination?

Valuation professionals provide expertise in market analysis, credit assessment, and rate determination methodologies that ensure accurate and supportable IBR calculations. These experts understand both technical requirements and practical implementation challenges, helping companies develop consist

What Is Incremental Borrowing Rate? Plain English Guide

Last Updated: December 2025

The incremental borrowing rate (IBR) is the interest rate your company would pay to borrow money on a collateralized basis , secured by the same type of asset you are leasing , over the same period as your lease. Under the new lease accounting standard (ASC 842 in the US, effective for most private companies since 2022), the IBR is the discount rate your accountant uses to calculate the dollar value of your lease obligations that now must appear on your balance sheet. If you have recently received an audit request for IBR documentation and have no idea what it means, this guide explains it in plain English.

The reason IBR matters for your business has nothing to do with the interest you are actually paying on a lease. You probably do not pay interest on your office lease , you pay monthly rent. But accounting rules require that long-term lease commitments be recognized as both an asset (the right to use the space) and a liability (the obligation to pay rent over the lease term) on your balance sheet. To translate future rent payments into today’s dollars, your accountant needs a discount rate. The IBR is that rate. A higher IBR produces a lower present value of those future payments , meaning smaller balance sheet numbers. A lower IBR produces larger numbers. Sofer Advisors, headquartered in Atlanta, GA, specializes in this area for middle-market businesses across Georgia.

Key Takeaways

IBR is the rate your auditor uses to discount future lease payments into present value , it directly determines the size of the right-of-use (ROU) asset and lease liability on your balance sheet
You do not need to calculate IBR yourself , but you do need to provide your accountant with the financial information needed to determine a defensible rate, or engage a valuation firm to provide one
A typical IBR for a profitable middle-market private company with a 5-7 year office lease in the current rate environment (2026) runs approximately 5-8%
If your auditor is asking for IBR documentation, it typically means they need evidence of how the rate was determined , a process, a data source, and a signed document , not just a number you picked
Getting the IBR wrong can materially misstate your balance sheet and trigger audit adjustments , a 1% error on a 10-year lease with $300,000 in annual payments changes your lease liability by approximately $200,000

What Does Your Auditor Actually Need From You?

When your auditor asks for IBR documentation, they are asking for three things, not one. They want the rate itself, the methodology used to arrive at it, and the data sources that support the methodology. “We used 6%” without any support for where 6% came from is not sufficient audit evidence , it will generate a follow-up request that extends your audit timeline.

Your auditor needs to confirm that your IBR reflects what a lender would actually charge your company for a secured loan with the same term as your lease. This rate depends on your company’s credit profile (how likely you are to repay), the type of asset securing the loan (real estate, equipment, vehicles), and the interest rate environment at the time the lease started. Rates locked in during low-interest-rate periods (2019-2021) look very different from rates for leases commenced in 2023 or 2024 following the Federal Reserve’s rate cycle.

The cleanest way to satisfy the auditor’s request is to engage a valuation professional , someone like the team at Sofer Advisors, founded by David Hern CPA ABV ASA , to provide a written IBR determination with full methodology documentation. The professional provides the rate, the market data, the methodology narrative, and a signed certification. Your auditor accepts the third-party determination as sufficient evidence, and your close moves forward without extended back-and-forth.

Why Does ASC 842 Require Lease Liabilities on the Balance Sheet?

Before ASC 842 took effect, most operating leases were kept entirely off the balance sheet , your rent commitment for a 10-year office lease appeared only as a footnote disclosure, not as a number in your assets and liabilities. The Financial Accounting Standards Board (FASB) changed this beginning in 2019 for public companies and 2022 for most private companies, concluding that long-term lease obligations represent genuine economic liabilities that lenders, investors, and other users of financial statements need to see transparently.

The change has a significant practical effect on private companies. A company with five office leases totaling $200,000 per year in rent over remaining 7-year terms now carries approximately $950,000-$1.1 million in lease liabilities on its balance sheet (depending on the IBR applied). That same liability affects your debt-to-equity ratio, your working capital calculation, and potentially your compliance with any financial covenants in your bank credit agreement. This is why getting the IBR right matters , it is not an abstract accounting exercise but a number that directly affects your loan compliance and financial ratios.

Annual Rent	Remaining Lease Term	IBR	Approx. Lease Liability
$100,000	5 years	5%	$432,900
$100,000	5 years	8%	$399,300
$100,000	10 years	5%	$772,200
$100,000	10 years	8%	$671,000
$300,000	7 years	6%	$1,673,000

How Does a Valuation Professional Determine Your IBR?

A valuation professional determines your IBR by building up a rate from observable market data. The process has three components: start with the risk-free rate (typically a US Treasury yield matching your lease term), add a credit spread based on your company’s financial profile, and adjust for the type of collateral securing the hypothetical loan (real estate, equipment, or other assets). The result is the collateralized borrowing rate specific to your company, asset type, and lease term , documented with references to Bloomberg, Federal Reserve data, or industry lending surveys.

The credit spread component is where your company’s financial health matters most. A well-established profitable business with low debt, strong cash flow, and an existing banking relationship will have a lower credit spread , and therefore a lower IBR , than a newer business with thin margins, high leverage, or no external financing history. Your accountant or valuation professional will look at your debt-to-EBITDA ratio, interest coverage ratio, and overall financial stability to position your credit profile relative to market benchmarks.

For most middle-market private companies with healthy financials and 5-7 year real estate leases, IBRs in the current environment (2026) run approximately 5-8%. Early-stage companies, businesses with higher leverage, or companies leasing specialized equipment rather than standard real estate typically see IBRs in the 8-14% range.

Can You Use Your Existing Bank Rate as the IBR?

This is the most common question business owners ask when they encounter the IBR requirement for the first time. The honest answer is: probably not, but it depends on whether your existing debt is a close match to your lease characteristics.

Your IBR must reflect a collateralized loan over a term similar to your lease. If you have a 7-year term loan secured by real estate that you took out at the same time your lease commenced , that rate might be a reasonable starting point. But most business owners have a revolving line of credit (short-term, unsecured) or an equipment loan (shorter term, different collateral) rather than a term loan that closely matches their office or warehouse lease. Using an unsecured revolving credit rate as the IBR for a 7-year office lease produces an overstated IBR , and potentially a materially understated lease liability.

Your auditor will evaluate whether your proposed IBR proxy is genuinely comparable to the hypothetical collateralized loan your lease represents. If it is not, the auditor will propose an adjustment , typically resulting in a lower IBR and a higher lease liability than you originally recorded. Engaging a valuation professional upfront produces a defensible IBR before the audit begins, avoiding this late-stage adjustment.

What Happens If You Used the Wrong IBR?

Using an incorrect IBR produces a misstated right-of-use asset and lease liability on your balance sheet. If the error is material , generally more than 5% of total assets or a specified dollar threshold in your audit engagement letter , your auditor will require a correction. If the correction occurs during the current year audit, it is recorded as an adjustment in the current period. If it affects prior periods, a restatement of prior-period financial statements may be required, which involves restating the balance sheet and income statement for each affected period, re-issuing prior-period financial reports, and potentially notifying lenders if the restated financials affect covenant calculations.

For private companies whose lenders rely on audited financial statements for annual covenant compliance review, a restatement can trigger a technical default even when the underlying business is perfectly healthy , because the restated debt-to-equity or leverage ratio may exceed covenant thresholds that were set based on the prior incorrect numbers. This is the real business cost of IBR errors , not just an accounting correction, but potential banking conversations that no business owner wants.

How Quickly Can You Get an IBR Determination?

Sofer Advisors provides IBR determinations with standard turnaround of 2-4 weeks from the date you submit your lease details and financial information. The information needed is straightforward: your lease agreements (or key economic terms , annual rent, term, commencement date, asset type), your most recent financial statements, and details on any existing debt obligations. The firm delivers a written IBR determination report with the calculated rate, full methodology documentation, market data references, and a signed certification suitable for audit file submission.

Rush turnaround , within one to two weeks , is available at a 25-50% premium for companies mid-audit or facing an imminent filing deadline. IBR determinations from Sofer Advisors typically cost $2,500-$9,000 depending on the number of leases and the complexity of the credit analysis. For companies with simple lease portfolios (one or two leases, straightforward asset types), the cost is at the lower end of this range.

Frequently Asked Questions

What is the incremental borrowing rate in simple terms?

The incremental borrowing rate (IBR) is the interest rate your company would pay to borrow money from a bank, secured by the same asset you are leasing, over the same period as your lease. Your accountant uses it to calculate how much your lease obligations are worth in today’s dollars , a process called discounting. The higher the IBR, the smaller your lease liability appears on the balance sheet; the lower the IBR, the larger the liability. The rate must reflect what a real lender would actually charge your company , not a rate you estimate based on gut feeling.

Why is my auditor asking about IBR?

Your auditor is asking about IBR because ASC 842 , the lease accounting standard that took effect for most private companies in 2022 , requires that operating leases longer than 12 months be recognized as liabilities on the balance sheet. The IBR is the discount rate used to calculate the size of that liability. Your auditor must verify that the IBR you used is supportable , that it reflects an actual market-based collateralized borrowing rate for your company’s credit profile and lease characteristics, supported by identifiable market data. Without documentation, the auditor cannot conclude that the liability amount is fairly stated.

Can I just use my bank’s prime rate as the IBR?

The prime rate is the base rate banks charge their most creditworthy commercial customers for short-term unsecured loans. It does not reflect the term or collateral characteristics of a specific lease , a 7-year collateralized real estate lease requires a different rate than the short-term unsecured prime rate. Using prime rate alone typically produces an IBR that is too high (because it does not adjust for the collateral benefit) or mismatched in term (because prime is effectively a short-term rate). Your auditor will likely question a prime rate IBR and ask for a more specifically supported calculation.

How much does IBR documentation cost?

A professional IBR determination with full audit-ready documentation typically costs $2,500-$9,000 from a credentialed independent valuation firm. For companies with multiple leases, the cost per lease decreases when leases can be grouped into portfolios sharing the same IBR. The $2,500-$9,000 cost compares favorably to the time cost of extended auditor back-and-forth over an undocumented IBR, and is far less costly than a balance sheet restatement if an incorrect IBR must be corrected. Sofer Advisors provides flat-fee IBR engagements with transparent pricing and 2-4 week standard delivery.

Do I need a new IBR every year?

No. The IBR is set at lease commencement and does not change over the lease term unless the lease is modified or specific reassessment events occur. You only need a new IBR calculation when: you sign a new lease, when an existing lease is modified (extended, expanded, or otherwise changed), or when ASC 842 requires reassessment of the lease term because you change your assessment of whether you will exercise a renewal or termination option. The IBR from your 2021 lease inception is the correct rate for that lease through its entire term , you do not recalculate it annually unless one of these triggers occurs.

What information does a valuation firm need to calculate my IBR?

To calculate your IBR, a valuation firm typically needs your lease agreement (or the key economic terms: annual rent, term, commencement date, remaining term), the type of asset being leased (office space, warehouse, equipment, vehicles), and your company’s financial profile , typically your most recent two to three years of financial statements or tax returns showing revenue, EBITDA or net income, total debt, and assets. The more complete your financial information, the more accurately the firm can position your credit profile relative to market benchmarks and produce a defensible IBR.

What if my lease started before ASC 842 was effective?

If your lease commenced before your ASC 842 effective date, you were required to determine the IBR as of your transition date , the beginning of the first period for which you applied ASC 842. Under the modified retrospective transition method (the most common approach for private companies), the IBR used is the rate as of the transition date , not the original lease commencement date. If your transition date IBR was not properly documented, your auditor may raise questions about the rate used in your opening balance sheet. the firm can provide a retroactive IBR determination for transition-date purposes if needed.

How does IBR affect my bank loan covenants?

ASC 842 lease liabilities appear on your balance sheet as long-term liabilities. If your credit agreement measures total debt or leverage using balance sheet liabilities, the new lease liability increases your measured leverage ratio. Many credit agreements include specific carve-outs that exclude operating lease liabilities from the leverage calculation , but this depends entirely on your specific credit agreement language. If your agreement does not exclude lease liabilities and the new liability pushes your leverage ratio above a covenant threshold, you may be in technical default. Review your credit agreement before your ASC 842 transition and model the impact of the new lease liabilities on your covenant ratios.

Can the firm help with both IBR and the broader ASC 842 lease accounting?

the firm specializes in the IBR determination component , providing the discount rate with full market data documentation that your accountant needs to complete the ASC 842 lease schedules. The firm does not prepare the full ASC 842 accounting implementation (the lease schedules, journal entries, and disclosure language) , that is typically handled by your external CPA or accounting team using your lease management software. the firm’ role is to provide the credentialed, market-calibrated IBR that your accountant plugs into the lease calculation , the piece most commonly challenged by auditors and most commonly lacking adequate documentation.

What is the difference between IBR and the rate implicit in the lease?

The rate implicit in the lease (RIIL) is the interest rate that makes the present value of the lease payments plus the unguaranteed residual value equal to the fair value of the asset. If your lessor discloses enough information for you to determine this rate, you are required to use it instead of the IBR. In practice, lessors rarely provide this information in arm’s-length commercial leases, so most business owners default to the IBR. If your lease is with a related party or a financing company that provides detailed pricing information, the RIIL may be determinable , and your accountant should use it instead of the IBR if it is clearly stated or easily calculable from information in the lease.

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Executive Summary

The incremental borrowing rate is the discount rate used under ASC 842 to calculate your company’s lease liabilities , determining the size of both the right-of-use asset and the lease obligation that now appear on your balance sheet. Business owners who receive audit requests for IBR documentation need a written rate determination from a credentialed professional, not just a rate estimate. Errors in IBR produce misstated balance sheets that may affect bank covenant compliance. the firm, founded by David Hern CPA ABV ASA, provides IBR determinations for business owners at $2,500-$9,000 with 2-4 week standard delivery and full audit-ready documentation.

What Should You Do Next?

Sofer Advisors provides IBR determinations backed by market data subscriptions, dual ABV and ASA credentials, and 180+ five-star Google reviews. Our plain-language reports give your auditor what they need and give you clarity on what the number means for your balance sheet.

SCHEDULE A CONSULTATION to get your IBR determined quickly and accurately , before your audit deadline creates time pressure.

About the Author

This guide was prepared by David Hern CPA ABV ASA, founder of Sofer Advisors – a business valuation firm headquartered in Atlanta, GA serving clients across the United States. David holds dual accreditations as an Accredited Senior Appraiser (ASA) and is Accredited in Business Valuation (ABV), credentials recognized by the IRS, SEC, and FINRA. He also holds the Certified Exit Planning Advisor (CEPA) designation. With 15+ years of valuation experience, David has served as an expert witness in 11+ cases across multiple jurisdictions and built Sofer Advisors into an Inc. 5000-recognized firm with 180+ five-star Google reviews. The firm’s full W2 employee team maintains subscriptions to all major valuation databases and operates under a next business day response policy.

For professional business valuation services, visit soferadvisors.com or schedule a consultation.

This article provides general information for educational purposes only and does not constitute legal, tax, financial, or professional advice, consult qualified professionals regarding your specific circumstances.

What Is Incremental Borrowing Rate? A Plain English Guide for Business Owners