FRS 102 summary
For organisations whose asset portfolio includes leased assets, leasing plays a crucial role in business operations; offering a way to use assets without large upfront investments. Whether it’s office space, equipment, or vehicles, leases provide flexibility and liquidity benefits. Accounting for such leases has undergone significant changes under FRS 102, the financial reporting standard for the UK and Ireland. Recent amendments now require lessees to recognise most leases on their balance sheets, aligning more closely with IFRS 16.
This blog will break down lease classification, right-of-use asset calculations, journals, and disclosure requirements to help organisations navigate the revised FRS 102 lease accounting guidance.
FRS 102 lease classification for lessees
Historically, FRS 102 classified leases as either finance leases or operating leases, meaning lessees accounted for operating leases off the statement of financial position. However, the recent amendments that took effect on 1 January 2026 largely remove this distinction for lessees. Now, lessees must recognise a right-of-use (ROU) asset and a lease liability on the statement of financial position for most lease agreements. Exemptions still apply for:
That said, exemptions exist for:
- Short-term leases (less than or equal to 12 months without a purchase option)
- Low-value assets (e.g., small office equipment like printers or laptops)
What qualifies as a lease under FRS 102?
Under FRS 102 guidance and similar to that of guidance provided under IFRS 16, a lease is an agreement that conveys the right to control the use of an identified asset for a period of time in exchange for consideration. Control exists if the lessee has both:
- The right to obtain substantially all the economic benefits from the use of the asset.
- The ability to direct its use.
FRS 102 lessor accounting
For lessors, the distinction between finance leases and operating leases remains unchanged.
- Finance leases transfer substantially all the risks and rewards of ownership to the lessee, requiring the lessor to derecognise the asset and recognise a lease receivable.
- For operating leases, the lessor retains the leased asset on their statement of financial position. The lessor recognises lease income on a straight-line basis over the lease term.
How to calculate the lease liability and ROU asset under FRS 102
When a lease is deemed to be in scope for FRS 102 reporting, the lessee records both a right-of-use asset and a lease liability equal to the present value of future lease payments.
The right-of-use (ROU) asset and lease liability are then systematically accounted for throughout the lease term with the lease liability functioning much like a loan. Each payment reduces the liability, but because payments are spread out over time, an interest expense is recorded separately.
To determine the present value of lease payments, lessees typically use the interest rate implicit in the lease. However, if this rate is not readily available, FRS 102 allows lessees to apply their incremental borrowing rate or their obtainable borrowing rate, i.e., the rate the lessee would expect to pay to finance a similar asset under similar terms.
The lease liability calculation includes:
- Fixed lease payments
- Variable lease payments that are based on an index or rate
- Residual value guarantees (if applicable)
- Purchase option price (if expected to be exercised)
- Termination penalties (if included in the lease)
The ROU asset is treated similarly to other tangible fixed assets, meaning it is depreciated over the shorter of the lease term or the asset’s useful life. This ensures that the cost of using the asset is spread out appropriately over time. This approach closely mirrors IFRS 16, maintaining consistency in how lease assets are systematically accounted for.
The right-of-use asset is initially measured at the lease liability amount
+ Plus any lease payments made before the commencement
+ Plus initial direct costs incurred by the lessee
– Less any lease incentives received
FRS 102 finance lease example (lessee)
The following example outlines the steps to calculate the opening lease liability and ROU asset for a lessee. It presents the complete lease liability schedule, the initial transition journals, and the journals for the first year of activity.
- Commencement Date: 1 January 2027
- Lease Term: 10 years
- Lease Payment (paid in arrears): £10,000 annually
- Lessee’s Obtainable Borrowing Rate: 6%
- Useful Life of Underlying Asset: 25 years
Lease liability schedule
Based on the data above, follow these steps to generate the FRS 102 lease liability schedule:
- Calculate the initial lease liability as the present value of the total remaining lease payments as of the commencement date.
- Calculate the initial right-of-use asset as the lease liability at commencement plus or minus any necessary adjustments.
- Amortise the lease liability over the lease term to reflect both lease payments and interest on the liability using the effective interest method.
- Depreciate the ROU asset in a systematic manner over the useful life of the underlying asset or the lease term, whichever is shorter.
The table below details the lease liability schedule at the lease commencement date:
As we can see in the above schedule, because no adjustments were necessary to calculate the opening ROU asset at commencement, the ROU asset is equal to the lease liability.
The ROU asset is then depreciated in a systematic and rational manner (e.g. straight-line in our case) over the shorter of the lease term or useful life of the underlying asset. In our example, the ROU asset is depreciated over the 10-year lease term, which is shorter than the leased asset’s useful life of 25 years.
Journals
The initial journals under FRS 102 record the asset and liability on the statement of financial position as of the lease commencement date. The following journal entry records this balance on 1 January 2027:
Using the lease liability schedule, the year-end journal entries record the first year’s activity:
FRS 102 lessee disclosures
Within the notes to the financial statements, an entity is expected to present both qualitative and quantitative disclosures regarding their leasing activities for the respective reporting period(s). The quantitative disclosures required by FRS 102 for lessees include but are not limited to:
- The carrying amount of all ROU assets summarized by asset class as of the end of the reporting period
- Interest expense on lease liabilities
- Expense information for short-term and low-value leases (if applicable)
- Expense relating to variable lease payments not included in the measurement of lease liabilities
- Income from subleasing right-of-use assets
- Maturity analysis of lease payments
- Gains or losses arising from sale and leaseback transactions
Furthermore, the lessee is required to disclose certain qualitative information to help financial statement users understand the entity’s leases and leasing activities, including the following:
- Summary of leasing activities
- Commitments for leases not yet commenced (i.e. a liability is not yet recorded on the statement of financial position)
Summary
The 2026 FRS 102 amendments significantly change lessee accounting by requiring recognition of right-of-use assets and lease liabilities. Lessors continue with the traditional finance vs. operating lease classification.
Companies should assess the impact of these changes on their financial reporting and ensure they are prepared for the transition. CFOs and Financial Controllers must evaluate how lease recognition impacts borrowing covenants, key metrics like gearing ratios, and the overall presentation of the statement of financial position.
