Uncertainty on discount rates

By Emilio Macerola
Auditor
5 August 2022

In a period of economic unrest and rising interest rates, there are ongoing uncertainties that need to be considered in arriving at the appropriate discount rate.

What is a Discount Rate?

The discount rate refers to the rate of interest applied to future cash flows to determine their present value. The discount rate should reflect the market’s present assessments of the time value of money for the periods until the end of the assets or liabilities useful life and the risks associated with the asset or liability. As a method for initial or subsequent measurement, this discount rate is used as a
present value technique to calculate the fair value, value in use, or other current value of an asset or liability.

The Accounting Standards most impacted

The main accounting standards that include requirements in relation to discount rates are in the table below. 

Accounting Standard Application of Discount Rate
AASB 119, Employee Benefits
  • Under the guidance of AASB 119, the discount rates are used to discount post-employment benefit obligations, as the P&L includes interest cost on the defined benefit obligation, thus interest cost is calculated using the discount rate.
AASB 136, Impairment of Assets
  • Under the guidance of AASB 136, the discount rates are used to determine the recoverable amount / value in use of an asset on a pre-tax basis.
AASB 137, Provisions, Contingent
Liabilities and Contingent Assets
  • Under the guidance of AASB 137, the discount rates are used to determine the present value of the expenditures expected to be required to settle an obligation on a pre-tax basis.
AASB 13, Fair Value Measurement
  • Under the guidance of AASB 13, discount rates are used to determine fair value.


Uncertainty regarding appropriate Discount Rates

As the future cash flows from an asset or liability are frequently subject to uncertainty, due care should be taken with choosing the appropriate discount rate, as the following should be considered:

  • The interest rates used to discount cash flows should be consistent with the perceived risk in the estimated cash flows 
  • Estimated cash flows and discount rates should be free of bias and unrelated factors to the asset or liability
  • The estimated cash flows and discount rates should reflect various possible outcomes in terms of the amount or timing of those cash flows
  • Consider the various series of future cash flows that the entity expects to derive from
    the asset or liability
  • Consider using separate discount rates for different future periods when the value in use is sensitive to risk differences between periods.

Where the discount rates used have changed materially, companies must consider whether the effects of these changes must be disclosed.

For assistance with arriving at the appropriate discount rate, please contact your local PKF advisor.

To read more articles in the Winter 2022 edition of Clarity, click here