FRS 102 summary
For organizations 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 recognize most leases on their balance sheets, aligning more closely with IFRS 16.
This blog will break down lease classification, right-of-use asset calculations, journal entries, and disclosure requirements to help organizations navigate the revised FRS 102 lease accounting guidance.
FRS 102 lessee lease classification
Historically, FRS 102 classified leases as either finance leases or operating leases, with operating leases being treated as off-balance sheet transactions. However, with the most recent amendments set to take effect on January 1, 2026, the distinction between the two is largely removed for lessees. Now, most lease agreements will require recognition of a right-of-use (ROU) asset and a lease liability on the balance sheet.
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 is considered 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 derecognize the asset and recognize a lease receivable.
- Operating leases retain the leased asset on the lessor’s balance sheet, with lease payments recognized as income on a straight-line basis over the lease term.
How to calculate the 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)
In the example below, we’ll outline the steps to calculate the lessee’s opening lease liability and ROU asset and present the complete amortization schedule, followed by the initial transition journal entry and the journal entry for the first period’s activity.
- Commencement Date: January 1, 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
Amortization schedule
Based on the facts above, we’ll take the following steps to generate the FRS 102 amortization 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.
- Amortize 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.
Using the values noted above, the amortization schedule at the commencement date of the lease is as follows:
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.
Journal entries
The initial journal entry under FRS 102 records the asset and liability on the balance sheet as of the lease commencement date. Below we present the entry recorded as of 1/1/2027 for our example:
Utilizing the amortization table, the journal entry for the end of the first period is as follows:
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 balance sheet)
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. Businesses using leases should consider the effect on their financial ratios, covenants, and overall balance sheet presentation.
