Worked FRS 102 Lease Example
This worked example walks through a complete FRS 102 Section 20 lease calculation from start to finish. We take a realistic 5-year UK office lease with a rent-free period and show every step: determining the discount rate, calculating the lease liability and ROU asset, recording the Day 1 journal entry, and producing the first year of amortization entries.
The Lease Scenario
ABC Ltd, a UK SME, signs a 5-year office lease commencing 1 January 2026. The landlord offers a 6-month rent-free period as an incentive. ABC Ltd incurs legal fees arranging the lease and estimates dilapidation costs to restore the premises at lease end.
Lease Details
Step 1: Determine the Discount Rate
FRS 102 requires lease payments to be discounted at the rate implicit in the lease. When this rate cannot be readily determined (which is typical for lessees), the entity uses its obtainable borrowing rate (OBR) — the rate at which it could borrow an equivalent amount, over a similar term, with similar security. For UK SMEs, Lease102 calculates the OBR using the current SONIA term rate plus a credit spread appropriate to the company's risk profile.
FRS 102 Reference: FRS 102.20.51–20.52
Why OBR, not IBR?
OBR Calculation
Step 2: Calculate the Lease Liability
The lease liability at commencement equals the present value of all future lease payments, discounted at the OBR of 6.50%. The rent-free months have £0 payments, so only the 54 payments of £2,500 (months 7–60) contribute to the present value. Using Act/365 day count, each payment is discounted based on the actual number of days from commencement to payment date.
FRS 102 Reference: FRS 102.20.50
What payments are included?
Present Value Calculation
Step 3: Determine the ROU Asset
The right-of-use asset at commencement equals the lease liability plus any initial direct costs and restoration obligations, less any incentives received at or before commencement. The rent-free period is already reflected in the payment schedule (as £0 payments), so it does not separately reduce the ROU asset.
FRS 102 Reference: FRS 102.20.13–20.14
| Component | Amount | FRS 102 Reference |
|---|---|---|
| Lease liability (PV of payments) | £113,617.41 | 20.50 |
| Add: Initial direct costs (legal fees) | £2,500.00 | 20.13(b) |
| Add: Restoration obligation (dilapidations) | £8,000.00 | 20.13(c), Section 21 |
| Less: Incentives received at commencement | £0.00 | 20.14 |
| ROU Asset at commencement | £124,117.41 |
Step 4: Day 1 Journal Entry
At commencement on 1 January 2026, ABC Ltd records the following journal entry to recognise the lease on its balance sheet. The ROU asset is debited, and three credits reflect the lease liability, the cash paid for legal fees, and the provision for dilapidations.
Balance sheet impact
Journal Entry — 1 January 2026
Step 5: Year 1 Amortization Schedule
Each month, Lease102 calculates: (1) interest expense on the opening lease liability using the period rate derived from Act/365, (2) principal reduction equal to the payment minus interest, and (3) straight-line depreciation on the ROU asset. During the rent-free months (1–6), no payment is made so interest accrues and increases the liability. From month 7 onward, payments exceed interest, reducing the liability.
FRS 102 Reference: FRS 102.20.15–20.18
| Month | Date | Opening Balance | Interest | Payment | Principal | Closing Balance |
|---|---|---|---|---|---|---|
| 1 | Feb 2026 | £113,617.41 | £609.32 | £0.00 | –£609.32 | £114,226.73 |
| 2 | Mar 2026 | £114,226.73 | £553.16 | £0.00 | –£553.16 | £114,779.89 |
| 3 | Apr 2026 | £114,779.89 | £615.55 | £0.00 | –£615.55 | £115,395.44 |
| 4 | May 2026 | £115,395.44 | £598.84 | £0.00 | –£598.84 | £115,994.28 |
| 5 | Jun 2026 | £115,994.28 | £622.06 | £0.00 | –£622.06 | £116,616.34 |
| 6 | Jul 2026 | £116,616.34 | £605.17 | £0.00 | –£605.17 | £117,221.51 |
| 7 | Aug 2026 | £117,221.51 | £628.64 | £2,500.00 | £1,871.36 | £115,350.15 |
| 8 | Sep 2026 | £115,350.15 | £618.61 | £2,500.00 | £1,881.39 | £113,468.76 |
| 9 | Oct 2026 | £113,468.76 | £588.84 | £2,500.00 | £1,911.16 | £111,557.60 |
| 10 | Nov 2026 | £111,557.60 | £598.27 | £2,500.00 | £1,901.73 | £109,655.87 |
| 11 | Dec 2026 | £109,655.87 | £569.05 | £2,500.00 | £1,930.95 | £107,724.92 |
| 12 | Jan 2027 | £107,724.92 | £577.72 | £2,500.00 | £1,922.28 | £105,802.64 |
Step 6: Monthly Journal Entries
Each month requires two journal entries: one for the lease liability (interest accrual and payment allocation) and one for ROU asset depreciation. Here is the entry for Month 7 (August 2026) — the first month with a cash payment.
Rent-Free Month (e.g. Month 1)
During the rent-free period, interest accrues on the liability but no payment is made. The liability increases each month.
Journal Entry — Month 1 (February 2026)
Payment Month (e.g. Month 7)
Once payments begin, each payment is split between interest expense and principal reduction of the lease liability.
Journal Entry — Month 7 (August 2026)
Key Takeaways
This worked example illustrates several important aspects of FRS 102 lease accounting that are commonly misunderstood.
Rent-free periods increase the liability
During the 6-month rent-free period, interest accrues but no payment is made. The lease liability grows from £113,617 to £117,222 before the first payment. This is correct under FRS 102 — the rent-free benefit is already reflected in the lower present value at commencement.
Interest is front-loaded
Like a mortgage, more of each early payment goes to interest and less to principal. In Month 7, only £1,871 of the £2,500 payment reduces the liability. By Year 5, almost the entire payment is principal reduction. Total interest over the lease term is £21,383.
P&L impact: depreciation plus interest
The monthly P&L charge is depreciation (£2,069) plus interest (variable, starting at £609). This is higher than the cash rent of £2,500 in the early months and lower in later months. Over the full term, total P&L charges equal total cash payments plus the non-cash costs (restoration provision).
Interest varies with Act/365
Using Act/365 day count, interest amounts vary slightly month to month based on the actual number of days in each period. February (28 days) produces less interest than March (31 days). This matches Excel XNPV calculations and is the Lease102 default.
Calculate your own lease
Enter your lease details and Lease102 generates the full FRS 102 amortization schedule, journal entries, and disclosure notes automatically.