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.
What's Changing in January 2026
The Financial Reporting Council (FRC) issued the third edition of FRS 102 in March 2024, with significant changes to lease accounting effective for periods beginning on or after 1 January 2026.
Key Changes at a Glance
- Operating/finance lease distinction eliminated for lessees
- Most leases now recognized 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 recognizing rent expense on a straight-line basis. Under the new rules, almost all leases must be capitalized, showing both an asset (the right to use the leased item) and a liability (the obligation to make payments).
Who Is Affected
These changes apply to all entities reporting under FRS 102 — that's approximately 260,000+ UK companies. 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)
Lease Liability Calculation
Under FRS 102.20.50, 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) + PV(in-substance fixed) + PV(residual guarantees) + PV(purchase option if reasonably certain)
Payments to Include
- • Fixed payments — regular rent/lease payments
- • In-substance fixed payments — variable payments that are effectively unavoidable
- • Residual value guarantees — amounts expected to be payable
- • Purchase options — if reasonably certain to exercise
- • Termination penalties — if lease term assumes termination
Right-of-Use Asset
Per FRS 102.20.13-14, the ROU asset is initially measured as:
Initial ROU Asset (A₀):
A₀ = L₀ + Initial Direct Costs − Incentives Received + Restoration Costs
Important: Lease incentives reduce the ROU asset, NOT the lease liability. This is a common error.
Subsequent Measurement
The ROU asset is depreciated on a straight-line basis over the shorter of the lease term and the asset's useful life. The lease liability is reduced by payments, with interest expense recognized using the effective interest method.
Discount Rate: OBR vs IBR
The discount rate is one of the most challenging aspects of FRS 102 lease accounting. FRS 102.20.51-52 introduces the Obtainable Borrowing Rate (OBR) as a simplification for SMEs.
Implicit Rate
The rate that causes PV of payments + residual to equal fair value + lessor costs. Rarely determinable for lessees.
OBR (Recommended for SMEs)
The rate to borrow the total undiscounted payments over a similar term. Simpler than IBR.
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
FRS 102 requires a modified retrospective approach on transition. This means:
- No restatement of prior year comparatives
- Cumulative adjustment to retained earnings at transition date
- Lease liability = PV of remaining payments at transition
- ROU asset = lease liability (adjusted for prepayments/accruals)
Practical Expedient (FRS 102.20.A3)
If you're already reporting under IFRS 16, you can use those carrying amounts as your opening FRS 102 balances. This must be applied to all leases and disclosed.
Exemptions
Two exemptions allow lessees to continue expensing certain leases:
Short-Term Leases
Leases with a term of 12 months or less (at commencement, including extension options reasonably certain to exercise).
Low-Value Assets
Assets that are low value when new (e.g., laptops, phones, small furniture). No monetary threshold — assessed by type.
Note: There is NO value-based exemption for SMEs in FRS 102. Even a single property lease must be capitalized (unless short-term).
Peppercorn Leases
A peppercorn lease is a legally binding lease where the rent is nominal—typically £1 per year—rather than market rate. Treatment under FRS 102 depends on your entity type.
Commercial Entities
- • Use actual rent (£1) in calculations
- • Liability and ROU asset ≈ £0
- • Market value NOT on balance sheet
- • Disclose if related party
Public Benefit Entities
- • Liability uses actual rent (≈ £0)
- • ROU asset at MARKET VALUE
- • Difference = Donation Income
- • Market value on balance sheet
FRS 102 Reference: Commercial entities follow Section 20.50. PBEs follow Section 34.94-97 for concessionary arrangements.
Disclosure Requirements
FRS 102 requires extensive disclosures about lease arrangements:
- • Depreciation charge for ROU assets by class
- • Interest expense on lease liabilities
- • Expense for short-term and low-value leases
- • Total cash outflow for leases
- • Maturity analysis of lease liabilities
- • Qualitative information about leasing activities and judgments
Lease102 Generates These Automatically
Our platform produces FRS 102-compliant disclosure notes ready for your financial statements. No manual compilation required.
Lease Modifications
FRS 102.20.54-58 requires remeasurement when lease terms change after commencement — rent reviews, term extensions, or scope changes.
Original Rate Retained
Index-linked changes (CPI, RPI, market reviews) and the three permitted cases in FRS 102.20.58.
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.
Related Resources
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