Termination Penalties in the FRS 102 Lease Term

A termination penalty is what you pay to bring a lease to an end early. Whether it belongs in the lease liability from Day 1, or is dealt with only when the lease actually ends, depends on what the lease term was assessed to be.

The Day-1 question

A termination penalty is included in the lease payments only where the lease term reflects you exercising a termination option. If you assessed the term as running to the break and paying the penalty, the penalty is part of what you discount. If you assessed the term as running to the end, there is no penalty in the measurement, because on that assessment you never pay one.

FRS 102 Reference: FRS 102.20.51

It follows the term assessment

The penalty and the lease term are one decision, not two. A penalty in the liability with a term running to full expiry is internally inconsistent.

Terminating a lease you did not expect to terminate

Where you end a lease early that was measured to its full term, this is not a change of estimate. The lease is derecognised: the remaining liability and the remaining carrying amount of the right-of-use asset both come off the balance sheet, and the difference, together with any penalty paid, goes to profit or loss as a gain or loss on termination.

Derecognition on early termination

At the termination date: Lease liability remaining £42,000 ROU asset carrying amount (£38,500) Termination penalty paid (£6,000) ------------------------------------------- Loss on termination (£2,500) The liability and the asset are both removed. Any dilapidations provision no longer required is released at the same time.

Partial termination

Giving up part of the asset, a floor of a building for example, is a scope reduction rather than a full derecognition. The liability and the asset are reduced in proportion to the part given up, and any difference goes to profit or loss. Where the reduction in scope is proportionate to the reduction in payments, the original discount rate can be kept.

What happens to the dilapidations provision

Ending a lease usually settles or releases the make-good obligation. Where the provision is no longer required it is released; where the works are actually done, the provision is used. Either way it is dealt with at the termination date rather than being left carried forward against a lease that no longer exists.

In Lease102

Recording a termination sets the termination date, derecognises the lease from that date and produces the gain or loss. Every downstream surface is termination-aware: the amortisation schedule stops, the roll-forward reports show the derecognition as its own movement rather than an unexplained drop, and the lease is excluded from journals and disclosures for periods after the termination date.

Terminate, do not delete

Deleting a lease removes the history an auditor needs. Recording the termination keeps the full trail and shows the movement in the notes.

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