FRS 102 Section 20
Lease Accounting Guide
Everything UK and Ireland SMEs need to know about the FRS 102 amendments effective from January 2026. Written for finance professionals, not accountants.
FRS 102 Section 20 in 60 seconds
FRS 102 Section 20 is the UK accounting standard for leases. From periods beginning on or after 1 January 2026, lessees must put almost all leases on the balance sheet as a right-of-use (ROU) asset and a matching lease liability.
- Recognise a lease liability at the present value of unpaid lease payments.
- Discount using the obtainable borrowing rate (OBR) for most UK SMEs, built from SONIA plus a credit spread.
- Recognise a right-of-use asset equal to the liability, plus initial direct costs and restoration provisions, less incentives received.
- Charge interest on the liability and straight-line depreciation on the ROU asset to P&L each period.
- Exempt short-term leases (12 months or less) and low-value asset leases (laptops, tablets, small office equipment) if you choose.
Every company, LLP, qualifying partnership and charity reporting under FRS 102 is affected, including small entities applying Section 1A. Micro-entities on FRS 105 and groups already on IFRS 16 are not. For the full walkthrough of recognition, exemptions, measurement and disclosures, with the paragraph references auditors ask for, see FRS 102 Section 20, explained.
What's Changing in January 2026
The Financial Reporting Council (FRC) issued the Periodic Review 2024 amendments to FRS 102 in March 2024, consolidated into the September 2024 edition of the standard. They change lease accounting for periods beginning on or after 1 January 2026.
Key Changes at a Glance
- Operating/finance lease distinction eliminated for lessees
- Most leases now recognised on balance sheet
- Right-of-Use (ROU) asset and lease liability required
- Aligns closely with IFRS 16 (with simplifications)
- New disclosure requirements
Previously, lessees could keep operating leases off the balance sheet, only recognising rent expense on a straight-line basis. Under the new rules, almost all leases must be capitalised, showing both an asset (the right to use the leased item) and a liability (the obligation to make payments). For a focused walkthrough of what changed, who is affected and the transition steps, see the 2026 changes explained.
Who Is Affected
These changes apply to every company, LLP, qualifying partnership and charity reporting under FRS 102, including small entities applying Section 1A. If you have any leases (property, vehicles, equipment), you need to comply.
Affected
- • Companies reporting under FRS 102
- • LLPs and qualifying partnerships
- • Charities using FRS 102
- • Any entity with operating leases
Not Affected
- • Micro-entities using FRS 105
- • Entities already on IFRS 16
- • Lessors (different rules apply)
FRS 102 applies in the Republic of Ireland as well as the UK, so Irish companies face the same requirements on the same timetable: see the Ireland guide for euro leases and €STR-based discount rates.
Lease Liability Calculation
Under FRS 102.20.49, the lease liability is measured at the present value of future lease payments. Use our free lease liability calculator to estimate your Day 1 balance.
Initial Lease Liability (L₀):
L₀ = PV(fixed payments less incentives receivable) + PV(in-substance fixed) + PV(index-linked payments at the commencement date index) + PV(residual guarantees) + PV(purchase option if reasonably certain) + PV(termination penalties)
Payments to Include (FRS 102.20.51)
- • Fixed payments – regular rent, less any lease incentives receivable (20.51(a))
- • In-substance fixed payments – variable payments that are effectively unavoidable (20.52)
- • Index-linked payments – rents that move with an index or a rate, such as RPI or CPI uplifts and market rent reviews, measured using the index or rate at the commencement date (20.51(b), 20.53-20.54)
- • Residual value guarantees – amounts expected to be payable (20.51(c))
- • Purchase options – if reasonably certain to exercise (20.51(d))
- • Termination penalties – if the lease term reflects terminating (20.51(e))
Right-of-Use Asset
Per FRS 102.20.46-20.48, the ROU asset is initially measured as:
Initial ROU Asset (A₀):
A₀ = L₀ + Initial Direct Costs − Incentives Received + Restoration Costs
Important: timing decides where an incentive lands. An incentive received at or before the commencement date reduces the ROU asset at its nominal amount (FRS 102.20.47(b)) and does not touch the liability, which is the common error. An incentive receivable after commencement is a negative lease payment and so reduces the liability (FRS 102.20.51(a)).
Subsequent Measurement
The ROU asset is depreciated applying the Section 17 requirements (FRS 102.20.57), so the method should reflect the pattern in which the benefit is consumed; straight-line is the usual choice, not a requirement. The period depends on the lease (FRS 102.20.58). Where the lease transfers ownership by the end of the term, or the ROU asset's cost reflects that a purchase option will be exercised, depreciation runs to the end of the underlying asset's useful life. Otherwise it runs to the earlier of the end of the ROU asset's useful life and the end of the lease term. The lease liability is reduced by payments, with interest recognised at a constant periodic rate on the outstanding balance (FRS 102.20.63).
Discount Rate: OBR vs IBR
The discount rate is one of the most challenging aspects of FRS 102 lease accounting. FRS 102.20.49 asks for the interest rate implicit in the lease where it can be readily determined. Where it cannot, the lessee chooses, lease by lease, between the incremental borrowing rate and the obtainable borrowing rate (OBR), which are alternatives the standard does not rank. The OBR is the simpler of the two to evidence, which is why we default to it.
Implicit Rate
The rate that causes PV of payments + residual to equal fair value + lessor costs. Use it if readily determinable; it rarely is.
OBR
The rate to borrow the total undiscounted payments over a similar term. Simpler to evidence, and our default for SMEs.
IBR
The rate to borrow funds with similar security for a similar asset. The equal alternative to OBR, chosen lease by lease.
How Lease102 Calculates OBR
We pull live SONIA rates from the Bank of England and €STR from the ECB daily. You provide your estimated credit spread (or we help you estimate it), and we calculate the OBR automatically.
Transition Approach
Transition is dealt with in Section 1, paragraphs 1.46 to 1.58, not in Section 20. The revised Section 20 is applied retrospectively, but comparatives are not restated (FRS 102 1.46 and 1.47). This means:
- No restatement of prior year comparatives (FRS 102 1.47)
- Cumulative adjustment to retained earnings at the date of initial application (1.47)
- Lease liability = PV of remaining payments at that date (1.51(a))
- ROU asset = lease liability adjusted for prepaid and accrued lease payments (1.51(b))
- A description of the transitional provisions applied (1.50)
Practical Expedient (FRS 102 1.48)
If lease liabilities and right-of-use assets have already been calculated under IFRS 16 so that the entity can be included in consolidated financial statements prepared under IFRS Accounting Standards, those carrying amounts may be used as the opening FRS 102 balances instead of applying paragraphs 1.51 to 1.54. An entity taking this route must apply it to all of its leases and disclose that it has done so.
Exemptions
A lessee may choose not to capitalise two kinds of lease and to expense the payments instead, on a straight-line basis or another systematic basis that better represents the pattern of benefit (FRS 102.20.5, 20.6):
Short-Term Leases
A lease term of 12 months or less at the commencement date, including any extension option reasonably certain to be exercised. A lease that contains a purchase option is never short-term.
Low-Value Assets
Assets of low value when new (e.g. laptops, phones, small furniture). The asset must be usable on its own and not highly dependent on other assets (20.10). Vehicles, plant, property, boats and aircraft are never low value (20.11).
Note: there is no monetary threshold and no small-company exemption. Low value is judged on the asset's own value when new, on an absolute basis, whether or not the lease is material to you, and the size of the lease payments has no bearing on it (FRS 102.20.9). A single property lease goes on the balance sheet unless it is short-term.
Peppercorn Leases
A peppercorn lease is one where the rent is nominal, typically £1 per year, rather than market rate. First ask whether it is a lease at all: where the contractual payments are so low as not to be substantive, the arrangement may not meet the definition of a lease, and nothing goes on the balance sheet (FRS 102.20.35). Where it is a lease, the below-market element is incoming resources and is added to the cost of the ROU asset. That applies to commercial entities as well as public benefit entities; only the measurement route differs.
Commercial Entities
- • Liability uses the actual rent (£1)
- • Below-market element is a government grant, where that is what it is
- • Measured under Section 24 Government Grants
- • ROU asset = liability + direct costs + grant element
- • Disclose if related party
Public Benefit Entities
- • Liability uses the actual rent (≈ £0)
- • Below-market element is a non-exchange transaction
- • Measured under PBE34.64-PBE34.74
- • ROU asset = liability + direct costs + donated element
FRS 102 Reference: 20.35 for both, with 20.49 for the liability and 20.47(e) for the incoming resources in the ROU asset. A peppercorn is not an exemption election: treat it as a question of whether a lease exists and, if it does, whether below-market consideration has been received.
Disclosure Requirements
A lessee's disclosures are set out in FRS 102.20.76 to 20.85:
- • A general description of significant leasing arrangements (20.76)
- • The types of discount rate used, and the proportion of the liability on each (20.77(c))
- • Interest expense on lease liabilities (20.80(a))
- • Expense for short-term leases and for leases of low-value assets (20.80(b), (c))
- • Variable lease payments not in the liability, and sublease income (20.80(d), (e))
- • Total cash outflow for leases (20.80(f))
- • Right-of-use assets by class: gross carrying amount, accumulated depreciation and a reconciliation showing additions and depreciation (20.81)
- • Commitments for the short-term and low-value leases kept off balance sheet (20.82)
No maturity analysis is asked of a lessee
That requirement falls on lessors (FRS 102.20.118 and 20.121), not on lessees, and a checklist that asks a lessee for one has been written from IFRS 16. Lease102 produces the quantitative notes and the right-of-use asset reconciliation from your lease data, ready to drop into the financial statements.
Lease Modifications
FRS 102.20.65-20.73 requires remeasurement when the payments or the term change after commencement. Rent reviews driven by an index or the market are reassessments (20.68-20.69); renegotiated changes are modifications (20.70-20.73).
Original Rate Retained
Index-linked and market rent reviews, which are reassessments (FRS 102.20.69), and the three permitted modification cases (20.72).
Revised Rate Required
Term extensions, scope increases with additional payments, and other significant changes.
Early Termination
When a lease ends before its contractual end date, derecognise both the liability and ROU asset. Any difference is a gain or loss in P&L.
Gain/Loss:
= Remaining Liability − ROU Asset NBV − Settlement Payment
ROU Asset Impairment
Under FRS 102 Section 27, ROU assets are subject to impairment when the recoverable amount falls below carrying value.
- • Significant decline in market rents
- • Asset partially vacant or sub-optimally used
- • Plans to dispose of or restructure operations
- • Evidence of physical damage or obsolescence
After impairment: Depreciation recalculates based on the reduced carrying value over the remaining lease term.
Frequently Asked Questions
When does FRS 102 Section 20 take effect?
The new lease rules apply to accounting periods beginning on or after 1 January 2026. A company with a 31 December year-end has its first compliant accounts for the year ending 31 December 2026. Earlier adoption is permitted.
Who has to comply with FRS 102 Section 20?
Every UK and Ireland company, LLP, qualifying partnership and charity reporting under FRS 102, including small entities applying Section 1A. Micro-entities reporting under FRS 105, and groups already on IFRS 16, are not affected.
What is the modified retrospective approach for FRS 102 transition?
Modified retrospective is the FRS 102 transition method that recognises a lease liability and matching ROU asset at the date of initial application (1 January 2026 for most entities), without restating comparatives. Existing operating leases are brought on-balance-sheet using the OBR at transition.
What is a peppercorn lease and how is it treated?
A peppercorn lease is a lease at nominal rent (often £1 per year) used in not-for-profit and group settings. Under FRS 102 Section 20, the ROU asset is recognised at fair value of the right of use granted, with the difference between fair value and nominal payments treated as a donation or contribution.
How do I account for a lease modification under FRS 102?
Most modifications require remeasuring the lease liability using a revised discount rate. Pure index or rate changes can keep the original rate. A scope reduction proportional to a payment decrease can keep the original rate. Term changes, scope increases with new payments, and significant payment reprices need a revised rate.
Related Resources
Lease Calculator
Calculate your lease liability and ROU asset impact under FRS 102 Section 20.
Learn moreFRS 102 Section 20, explained
Recognition, the recognition exemptions, measurement, discount rates and disclosures.
Learn moreThe 2026 changes
What changed in FRS 102 lease accounting, who is affected and the five-step transition.
Learn moreFRS 102 in Ireland
How the lease amendments apply to Irish companies: euro leases and €STR rates.
Learn moreFRS 102 Software
Purpose-built FRS 102 lease accounting software for UK SMEs. Pricing, features, and comparison.
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