FRS 102: Accounting for leases

Historically, leases were classified as either operating or financing and the recognition and measurement requirements were dependent upon this classification. For a lessor, the good news is the impact of the amendments to FRS 102 to the classification and accounting for your leases is minimal. For a lessee, the changes are highly likely to be significant. Now is the time for businesses to review their current leases and those which will still be in place in 2026, when the amendments take effect.

Reviewing current and future leases

For accounting periods commencing on or after 1 January 2026, a lessee is required to account for almost all leases by bringing onto their balance sheet a right-of-use asset and a lease liability. An exemption from this requirement is available for short-term leases and for leases for which the underlying asset is of low value. A short-term lease is defined as a lease that at the commencement date has a lease term of 12 months or less. To determine whether the underlying asset is of low value, the lessee does not consider the value of the lease payments. The assessment of the asset is based on an absolute basis. Examples of assets which would not be of low value have been added to the standard and include cars and vans. For short-term leases and leases of asset with a low underlying value, lease payments are recognised on either a straight-line basis over the lease term or another systematic basis that is more representative of the pattern of the lessee’s benefit, similar to how operating leases have been accounted for historically.

The right-of-use asset is measured initially at the amount of the lease liability adjusted for lease payments made before the start of the lease, lease incentives received and initial direct costs. “Make-good” estimates, such as provisions for dismantling and restoring the leased asset to its original condition, recognised at the commencement of the lease also form part of the right-of-use asset.

After initial recognition, leased properties that meet the definition of an investment property must be accounted for using the fair value model. For other right-of-use assets, an accounting policy choice for each class of property, plant and equipment will allow the assets to be accounted for using either the cost or revaluation model. The cost model has been more widely used by IFRS adopters than the fair value model in practice.

The lease liability is measured at the present value of the lease payments which are not paid at the start of the lease. To discount payments, ideally the interest rate implicit in the lease would be used. As that is not often readily determined, businesses can choose to discount payments by either using their incremental borrowing rate or their obtainable borrowing rate. The choice of which of these to use is on a lease by lease basis. The standard includes requirements for the lease liability, the discount rate and the right-of-use asset held under the cost model for changes to your lease including rent reviews and lease modifications.

Implications for financial reporting

The implications for a business’s financial reporting are generally:

• Operating lease payments charged to profit or loss are reduced.
• Depreciation charge in profit or loss is increased.
• Interest charge/finance charge in profit or loss is increased.
• Fixed assets included in the balance sheet increase.
• The liabilities recorded in the balance sheet increase.

The FRC has introduced a modified retrospective transitional provision for lessees, meaning that the comparative figures are not adjusted. When the amendments are adopted, the opening balances for accounting periods commencing on or after 1 January 2026 are amended. (The transitional provision is the same if the amendments to FRS 102 are early adopted. Early adoption requires all of the changes to be implemented).

When to review current leases

The time for adopting the amendments may seem a long way off. We recommend businesses review their current leases that will still be in place in 2026 and consider:

• If the leases is of low-value assets.
• If it is possible to determine the interest rate implicit in the lease.
• Reviewing other agreements such as finance agreements, bonuses, share-based payments and other incentives to determine if they will be impacted by the changes in accounting.

For more information on FRS 102 and accounting for leases, please contact us.