The Discount Rate of IAS 36 – A Comment

Abstract

Discussing the guidance in IAS 36 on how to determine the discount rate for present value measurements of impairment reviews, Husmann and Schmidt (Accounting in Europe, 5, pp. 49–62, 2008) conclude that the standard's option to use ‘the entity's incremental borrowing rate’ should be removed. I argue that their conclusion is based on a misconception about what is meant by incremental borrowing, and that the incremental borrowing rate may be a useful approximation to the cost of capital within a Capital Asset Pricing Model (CAPM) framework. The reference to it is even more useful if CAPM is deemed not to hold. An important objection to the IAS 36 rules on the discount rate is that they are so different from the US GAAP rules: the former are detailed and adhere closely to the CAPM ideal, whereas the latter are general in nature, superficial and lack theoretical underpinnings. Any modification of the accounting standards' rules on the discount rate should first seek to remove that gap.

Acknowledgements

I received helpful comments from John Christian Langli, Christopher Nobes and Bernt Arne Ødegaard.

Notes

A more comprehensive discussion of the pre-tax discounting regime of IAS 36 is in Kvaal (2007).

For the sake of clarity I have added subscripts to the HS notation, and I write Eq for equity to distinguish it from the expectation operator, E.

For a review and update of these tests, see Fama and French (2004).