FRS 102 Lessor Accounting: Finance vs Operating
The 2026 amendments changed lessee accounting fundamentally, but lessor accounting under FRS 102 kept the familiar two-model approach: a lessor classifies each lease as a finance lease or an operating lease, and the accounting follows the classification (FRS 102.20.86-20.87). A company that both leases premises in and lets property out therefore applies two different models at once.
Classification happens once, at inception
A lease that transfers substantially all the risks and rewards incidental to ownership of the underlying asset is a finance lease; anything else is an operating lease. Classification is made at the inception date and is reassessed only if there is a lease modification: a change in estimates (the asset's economic life or residual value, for example) or a change in circumstances such as default by the lessee does not give rise to a new classification. The examples and indicators, and the 75% and 90% rules of thumb used in practice, are covered in the finance lease classification test topic.
FRS 102 Reference: FRS 102.20.86-20.91
Finance leases: a receivable, not an asset
A lessor under a finance lease derecognises the physical asset and instead presents a receivable equal to the net investment in the lease, measured using the interest rate implicit in the lease. The lease payments included are the fixed payments (less any incentives payable), index-linked variable payments, residual value guarantees, a purchase option price the lessee is reasonably certain to exercise, and termination penalties where the term reflects termination. Initial direct costs are picked up automatically by the implicit rate and are not added separately. Finance income is then recognised on a pattern giving a constant periodic rate of return on the net investment, the mirror image of a lessee's interest expense.
FRS 102 Reference: FRS 102.20.93-20.105
| Year | Opening investment | Finance income (6%) | Payment | Closing investment |
|---|---|---|---|---|
| 1 | £50,000.00 | £3,000.00 | £11,869.82 | £41,130.18 |
| 2 | £41,130.18 | £2,467.81 | £11,869.82 | £31,728.17 |
| 3 | £31,728.17 | £1,903.69 | £11,869.82 | £21,762.04 |
| 4 | £21,762.04 | £1,305.72 | £11,869.82 | £11,197.94 |
| 5 | £11,197.94 | £671.88 | £11,869.82 | £0.00 |
Operating leases: keep the asset, spread the income
A lessor under an operating lease keeps the asset on its balance sheet and depreciates it under its normal policy for similar assets. Lease payments are recognised as income on a straight-line basis over the lease term, unless another systematic basis is more representative of the pattern in which the benefit from the asset is diminished, or the payments are structured to rise in line with expected general inflation to compensate the lessor for inflationary cost increases. Because lease payments are defined net of incentives, an incentive given to the tenant (a rent-free period, a fit-out contribution) reduces the income spread across the term on that same basis. Initial direct costs of arranging the lease are added to the asset's carrying amount and expensed over the term on the same basis as the income (FRS 102.20.108).
FRS 102 Reference: FRS 102.20.106-20.112
Manufacturer and dealer lessors
A manufacturer or dealer using finance leases as a sales channel recognises revenue at the fair value of the underlying asset, or the present value of the lease payments discounted at a market rate if lower, with the related cost of sale and the resulting selling profit or loss recognised at the commencement date. If an artificially low rate of interest is quoted, the selling profit is restricted to what a market rate would produce. Costs of obtaining the lease fall outside the definition of initial direct costs and outside the net investment, so they are expensed at commencement rather than spread. No selling profit arises on an operating lease, which is not the equivalent of a sale.
FRS 102 Reference: FRS 102.20.97-20.100
Lessor disclosures
Every lessor gives a general description of its significant leasing arrangements, covering variable payments, renewal and purchase options, escalation clauses, subleases and restrictions where these are needed to understand the arrangements (FRS 102.20.114-20.115). Finance lessors then disclose selling profit or loss, finance income on the net investment and income from variable payments outside that measurement (20.116(a)), an explanation of significant changes in the carrying amount of the net investment (20.117), and a maturity analysis of undiscounted payments receivable, by year for at least five years with a total for the rest, reconciled to the net investment (20.118). Operating lessors disclose lease income, separately identifying income from variable payments that do not depend on an index or a rate (20.116(b)), apply the Section 17 disclosures with assets subject to operating leases disaggregated from owned assets (20.119-20.120), and give a maturity analysis of the undiscounted payments receivable (20.121).
FRS 102 Reference: FRS 102.20.114-20.121
Where Lease102 fits