As per the definition stated in ASC 842, one of the new lease accounting standards, the incremental borrowing rate is the “rate of interest that a lessee would have to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment”.
To calculate a lease’s liability, ASC 842 states that lessees should use the rate implicit in a lease to determine the present value of future lease payments.
The incremental borrowing rate is important because once it is clear that a contract includes a lease, the lease liability and ROU assets have to be recorded, and a rate needs to be determined in order to discount committed future lease payments. Since the rate implicit in the lease is so often not available, IBR is used.
There are about six factors to consider before calculating the incremental borrowing rate. These are:
Incremental interest is the amount of interest that is accrued on a mortgage loan that can be attributed to the incremental rate.