Purchase and Extension Options Under FRS 102
Extension, break and purchase options change the lease term, and the lease term drives every figure that follows. The test is not whether an option exists but whether you are reasonably certain to exercise it, judged at commencement.
What the lease term actually is
The lease term is the non-cancellable period, plus any periods covered by an extension option you are reasonably certain to exercise, plus any periods covered by a termination option you are reasonably certain NOT to exercise. An option you are not reasonably certain about is left out.
Judged at commencement, not at signature
A hire with no stated end date
Where a hire continues until one party gives notice, the non-cancellable period is the period the contract is enforceable for, and it stops being enforceable once each party can end it without the other's permission and without a penalty that matters. For an open hire that is the notice period, so the notice period is the term. Record this on the lease itself, by setting the term basis to rolling and giving the notice period, rather than as a break clause here. Where only the lessor may give notice, the notice period does not shorten your term.
Reasonably certain: what tips the balance
The threshold is high. It is not more likely than not, and it is not what you currently plan. It is whether the economics make exercising the option the obvious course.
Points towards reasonably certain
A significant leasehold improvement you have paid for and would lose; a below-market rent in the option period; relocation costs that would be substantial; the asset being specialised or hard to replace; a purchase option priced well below expected fair value.
Points away
An option priced at open market rent; an asset that is readily available elsewhere; a short remaining useful life; no meaningful cost to walking away.
Extension options
If you are reasonably certain to extend, the extension period is inside the term from Day 1: its payments are in the liability, and the asset is depreciated over the longer period. If you are not, the term stops at the break and the option is simply ignored until something changes.
Changing the tick on a measured lease
What the break date means
A break clause records one date, and it can mean two different things. A fixed break lets the lease be determined on a named day. A rolling break opens on a day and the lease then ends a notice period after notice is served, on a date nobody knows in advance. What This Date Is records which you hold, so the calculation reads the date correctly.
Leave it blank if you are unsure
The lease ends on this date
A fixed break date. Where you hold the break and are reasonably certain to exercise it, the lease term ends there and the liability and right-of-use asset are measured to it.
The break opens on this date
A rolling break. The date is when the option first becomes available, not when the lease ends, so it never shortens the term, whoever holds the break. When notice is served, record it under Add > Modification > Break option exercised.
Break clauses
A break clause held by you shortens the term where you are reasonably certain to exercise it. Whose break it is matters: a landlord-only break does not shorten your term, because the decision is not yours. Record who holds the break, not just that one exists. If a break is later exercised, by you or by the landlord, record it under Add > Modification > Break option exercised rather than by changing the break clause's assessment: the lease term changes and the liability is remeasured at a revised rate.
Whose break is it?
Purchase options
Where you are reasonably certain to exercise a purchase option, the option price goes into the lease payments and therefore into the liability. It also changes the depreciation period: where the lease transfers ownership, or a purchase option is reasonably certain to be exercised, the right-of-use asset is depreciated over the useful life of the underlying asset rather than the lease term.
FRS 102 Reference: FRS 102.20.51, 20.55-20.61
| Situation | Option price in the liability? | Depreciate over |
|---|---|---|
| Purchase option, reasonably certain to exercise | Yes | Useful life of the asset |
| Purchase option, not reasonably certain | No | Lease term |
| Lease transfers ownership at the end | Not applicable | Useful life of the asset |
When the assessment changes
If something happens that makes an option you had excluded reasonably certain, or vice versa, the lease is reassessed and the liability remeasured. A business decision to keep using the asset long term is the usual trigger. Because the term has changed, this is a case that needs a revised discount rate rather than the original one.
Options and the short-term exemption
The short-term exemption is assessed on the lease term as defined above, which includes reasonably certain extensions. A six-month lease with a renewal option you are reasonably certain to exercise has an expected term over twelve months, so the exemption is not available.
FRS 102 Reference: FRS 102.20.5(a), 20.6-20.8