Lease accounting under FRS 102 (September 2024)
The periodic review of UK and Ireland accounting standards which was finalised by the Financial Reporting Council (FRC) in 2024 was given significant prominence throughout 2025 due to the impact the changes will have on entities’ financial statements.
The two ‘headline’ areas that dominate the periodic review are in respect of lease accounting and revenue recognition. This article will examine some of the technical requirements of the new lease accounting provisions. Further articles will be published over the year looking at the other technical changes.
At the outset, it is worth noting that the new lease accounting requirements only apply to FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland. They do not affect FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime.
It is also worth noting that in September 2024, the FRC issued new editions of UK and Ireland accounting standards. These updated editions supersede the January 2022 editions (and the November 2022 edition of FRS 100 Application of Financial Reporting Requirements) and incorporate the periodic review amendments.
Operating and finance lease distinction
Under FRS 102 (September 2024) there is no distinction between an operating lease and a finance lease for lessees. This is because most leases for lessees will be recognised on-balance sheet as right-of-use assets with a corresponding lease liability.
There does, however, continue to be a distinction between an operating lease and a finance lease for lessors. It should be emphasised that as FRS 102 (September 2024) Section 20 Leases was rewritten as part of the periodic review amendments, the underlying accounting treatments for lessor accounting do not differ significantly from the previous accounting treatments.
A notable change for lessors is, however, in respect of intermediate lessors when classifying a sublease as a finance or an operating lease. FRS 102, para 20.92 states:
‘In classifying a sublease, an intermediate lessor shall classify the sublease as a finance lease or an operating lease as follows:
(a) If the head lease is a short-term lease that the entity, as a lessee, has accounted for applying paragraph 20.6, the sublease shall be classified as an operating lease.
(b) Otherwise, the sublease shall be classified by reference to the right-of-use asset arising from the head lease, rather than by reference to the underlying asset (eg the item of property, plant or equipment that is the subject of the lease).’
On-balance sheet lease accounting
The FRC has aligned FRS 102, Section 20 to that of IFRS® 16 Leases, albeit with some additional simplifications and practical expedients to allow the new accounting treatments to be proportionate to private entities.
Most leases will be recognised on-balance sheet, in much the same way as a previous finance lease was accounted for. However, there are two exemptions available for on-balance sheet recognition which relate to:
- Short-term leases; and
- Leases of assets of low value.
Short-term leases
The FRC has included a new definition of ‘short-term lease’ as follows:
‘A lease that, at the commencement date has a lease term of 12 months or less. A lease that contains a purchase option is not a short-term lease.’
This recognition exemption is applied by class of underlying asset.
The ‘lease term’ (a term also defined in the Glossary to FRS 102) is discussed in FRS 102, para 20.37 which clarifies that the term begins at the commencement date and includes any rent-free periods provided to the lessee by the lessor.
Leases of assets of low value
FRS 102, Section 20 focuses on highlighting examples of assets which are not low value. Consequently, there is no list in Section 20 of assets that might be low value. FRS 102, para 20.11 provides a list of underlying assets whose value would not be considered low value as follows:
- Cars, vans, buses, coaches, trams, trucks and lorries
- Cranes, excavators, loaders and bulldozers
- Telehandlers and forklifts
- Tractors, harvesters and related attachments
- Boats and ships
- Railway rolling stock
- Aircraft and aero engines
- Land and buildings
- Production line equipment
This list in paragraph 20.11 is not a comprehensive list and professional judgement will be needed to assess what is, and what is not, low value. Essentially, if a leased asset is something similar in value to the list in para 20.11, the leased asset will not be considered to be low value.
The FRC has taken a more permissive approach to defining low-value assets. FRS 102, para 20.9 clarifies that the assessment of the value of an underlying asset is performed on an absolute basis. Low-value assets would qualify for off-balance sheet recognition regardless of whether those leases are material to the lessee (hence materiality issues are irrelevant in determining whether, or not, a leased asset is low value). In addition, FRS 102, para 20.9 clarifies that the value of lease payments has no bearing on the assessment of whether an underlying asset is low value.
FRS 102, para 20.10 then states that an underlying asset can be low value only if:
(a) the lessee can benefit from use of the underlying asset on its own or together with other resources that are readily available to the lessee; and
(b) the underlying asset is not highly dependent on, or highly interrelated with, other assets.
There is no limit on the number of individual assets that can be considered as being low value for the purpose of the recognition exemption. The Basis for Conclusions in FRS 102 notes that low-value assets can include:
- Tablets and personal computers
- Small items of office furniture
- Telephones
This list is not exhaustive.
Initial application of the new requirements
FRS 102, para 1.47 confirms that the lessee must not restate comparative information (which is expected to be very welcome by preparers). Instead, the lessee recognises the cumulative effect of initially applying the new accounting treatments as an adjustment to the opening balance of retained earnings or other component of equity, as appropriate at the date of initial application. Hence, the right-of-use asset recognised is equal to the liability at the date of initial application, adjusted by the amount of any prepaid or accrued lease payments on the balance sheet prior to application of the amendments. This is known as the ‘modified retrospective approach’.
This means that prior year adjustments are not carried out on first-time adoption of FRS 102 (September 2024), Section 20. FRS 102, para 1.51(a) states that the lessee recognises a lease liability at the date of initial application at the present value of the remaining lease payments, discounted using:
- the lessee’s incremental borrowing rate; or
- the lessee’s obtainable borrowing rate.
The ‘lessee’s incremental borrowing rate’ is defined as:
‘The rate of interest a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment.’
The ‘lessee’s obtainable borrowing rate’ is defined as:
‘The rate of interest a lessee would have to pay to borrow, over a similar term, an amount similar to the total undiscounted value of lease payments to be included in the measurement of the lease liability.’
| Example – Initial application
Sunnie Ltd has a year end of 31 December 2026. At 1 January 2026, Sunnie had a lease agreement in place to rent some offices for £50,000 per annum with three years remaining (i.e. a total lease commitment of £150,000 remaining). If Sunnie Ltd were to take out a loan for £150,000 on 1 January 2026, it would pay interest at a rate of 7% per annum. Step 1: Calculate the present value of the remaining lease payments
Hence, on 1 January 2026, Sunnie Ltd will:
For simplicity, there are no accrued or prepaid amounts. Step 2: Make an adjustment (if necessary) for any lease payments in profit or loss Some clients may have posted all the lease payments to profit or loss over the year in which the periodic review amendments take effect. Hence, a journal may be needed to: · Dr Lease liability · Cr Lease rentals (profit or loss) Step 3: Measure the lease liability using the amortised cost method The lease liability is subsequently measured using the amortised cost method in FRS 102, Section 11 Basic Financial Instruments as follows:
At the end of 2026, the balance of £90,401 is split between the current liability portion of £43,672 (£90,401 less £46,729) and the non-current portion of £46,729. Step 4: Depreciate the right-of-use asset The right-of-use asset is depreciated in accordance with FRS 102, Section 17 Property, Plant and Equipment. However, if the lease term transfers ownership of the underlying leased asset to the lessee by the end of the lease term, or if the cost of the right-of-use asset reflects that the lessee will exercise a purchase option, the lessee depreciates the asset from the commencement date to the end of the asset’s useful life. Otherwise, the lessee depreciates the asset from the commencement date to the earlier of the end of the useful life or the end of the lease term. For simplicity, in this example we will depreciate the right-of-use asset over the remaining lease term (£131,216 / three years), hence:
Impact of the above
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For leases that were previously classified as operating leases, keep in mind that the initial lease liability is calculated at the present value of the remaining lease payments, discounted using either:
- The lessee’s incremental borrowing rate; or
- The lessee’s obtainable borrowing rate.
Not, the interest rate implicit in the lease (FRS 102, para 1.51(a)). This calculation applies to each lease in force at the date of initial application.
However, for new leases entered into after the date of initial application of the new lease accounting treatments, the lessee measures the lease liability at the present value of the lease payments that are unpaid. The interest rate implicit in the lease must be used to discount the lease payments if that rate can be readily determined. If the interest rate implicit in the lease cannot be readily determined, the lessee chooses (on a lease-by-lease basis) to apply either the lessee’s incremental borrowing rate or the obtainable borrowing rate (FRS 102, para 20.49).
Conclusion
This article has examined some of the core principles involved in the new lease accounting treatments, particularly those that need to be applied on initial application of the new rules. FRS 102, Section 20 is a very long section (at 126 paragraphs) and care will need to be taken to ensure that the technical detail is correctly interpreted (particularly in areas such as leases of assets of low value).
Category: Accounting and standards
