What Is FRS 102?
FRS 102 is the principal financial reporting standard for entities in the United Kingdom and Republic of Ireland that do not report under full IFRS. It applies to private companies, charities, and other non-publicly accountable entities operating under UK GAAP.
Section 20 of FRS 102 specifically covers lease accounting. The Financial Reporting Council (FRC) has introduced significant amendments to this section, effective for accounting periods beginning on or after 1 January 2026, bringing the lessee accounting model in line with IFRS 16.
Who Reports Under FRS 102?
Private companies, LLPs, charities, housing associations, and other entities in the UK and Ireland that are not required to use full IFRS. This includes most small and medium-sized entities (SMEs), though many large private companies also report under FRS 102.
What's Changing in Section 20
The core change is straightforward: lessees must now recognise most leases on the balance sheet. The previous distinction between operating and finance leases for lessees has been removed.
Before: Old Section 20
- Lessees classified leases as either operating or finance
- Operating leases were off-balance sheet, recognised as a rental expense on a straight-line basis
- Only finance leases appeared on the balance sheet as an asset and liability
After: Revised Section 20
- No lease classification for lessees. All leases follow a single model
- Lessees recognise a right-of-use (ROU) asset and a lease liability for most leases
- The lease liability equals the present value of future lease payments
- The ROU asset is depreciated over the lease term, with interest recognised on the liability
- Exemptions available for short-term leases (12 months or less) and low-value assets
Key point: The total expense over the life of a lease remains the same. It equals total cash payments regardless of accounting treatment. What changes is the timing and presentation: expense is front-loaded under the new model, and lease obligations are now visible on the balance sheet.
What Hasn't Changed
Lessor accounting remains largely unchanged. Lessors continue to classify leases as operating or finance leases based on whether substantially all risks and rewards of ownership transfer to the lessee.
Who Is Affected
Any entity reporting under FRS 102 with lessee lease contracts is affected. The impact depends on your existing lease portfolio:
Most Affected
Companies with significant operating leases for property, vehicles, or equipment. These leases were previously off-balance sheet and must now be recognised.
Moderately Affected
Companies that already had most leases classified as finance leases. The accounting treatment is similar, but the transition process still applies.
Minimally Affected
Companies with only short-term or low-value leases that qualify for exemptions. These can continue to be expensed.
Don't Assume You're Not Affected
Many contracts contain embedded leases that weren't previously identified, including serviced office agreements, IT hosting with dedicated hardware, and fleet management contracts. Review your contracts carefully.
Scope & Exemptions
FRS 102 Section 20 applies to any contract that conveys the right to use an asset for a period of time in exchange for consideration, even if the contract is not called a "lease". This includes leases for property, vehicles, equipment, and other tangible assets.
Short-Term Lease Exemption
Leases with a term of 12 months or less at commencement (including any renewal options you are reasonably certain to exercise) can be expensed on a straight-line basis rather than recognised on the balance sheet. This election is made by class of underlying asset.
Low-Value Lease Exemption
Leases for assets that have a low value when new can be expensed directly. This election is made lease-by-lease. FRS 102 provides more guidance than IFRS 16 on what qualifies, explicitly including:
- Office furniture, small printers, laptops, tablets, and telephones
The standard also explicitly excludes certain assets from the low-value exemption:
- Vehicles, construction equipment, farming equipment, boats, and ships
Practical tip: Even if you apply both exemptions, you still need to track these leases for disclosure purposes. The exemptions only remove the balance sheet recognition requirement.
Contracts Outside Scope
The following are outside the scope of Section 20:
- Service agreements that do not convey control over a specified asset
- Contracts where the supplier has substantive substitution rights
- Leases of intangible assets
- Leases to explore for or use minerals, oil, natural gas, and similar resources
The New Lessee Accounting Model
At lease commencement, lessees recognise two items on the balance sheet:
Lease Liability
The lease liability is measured at the present value of future lease payments, discounted using either:
- The interest rate implicit in the lease, if readily determinable (rare in practice)
- The lessee's obtainable borrowing rate: the rate the lessee would have to pay to borrow over a similar term, with similar security, to obtain an asset of similar value
Obtainable Borrowing Rate vs Incremental Borrowing Rate
FRS 102 uses the term "obtainable borrowing rate" rather than IFRS 16's "incremental borrowing rate". In practice, these are determined the same way. FRS 102 also allows a practical expedient to use a single discount rate for a portfolio of leases with similar characteristics. See our FRS 102 discount rates guide for a practical, step-by-step approach.
Lease payments included in the liability measurement are:
- Fixed payments (less any lease incentives receivable)
- Variable payments that depend on an index or rate (e.g. CPI-linked rent)
- Amounts expected to be payable under residual value guarantees
- The exercise price of a purchase option, if the lessee is reasonably certain to exercise
- Penalties for early termination, if the lease term reflects the lessee exercising that option
Right-of-Use Asset
The right-of-use asset is initially measured at an amount equal to the lease liability, adjusted for:
- Any lease payments made at or before commencement (less incentives received)
- Initial direct costs incurred by the lessee
- An estimate of dismantling, removal, or restoration costs (dilapidations)
Subsequent Measurement
Over the lease term:
- The lease liability is reduced by payments made and increased by interest charged
- The ROU asset is depreciated over the shorter of the lease term or the asset's useful life
- Interest expense is front-loaded (higher in earlier years), while depreciation is typically straight-line
| Year | Depreciation | Interest | Total FRS 102 Expense | Previous "Lease Expense" | Difference |
|---|---|---|---|---|---|
| 1 | 82,004 | 28,701 | 110,705 | 100,000 | +10,705 |
| 2 | 82,004 | 23,710 | 105,714 | 100,000 | +5,714 |
| 3 | 82,004 | 18,370 | 100,374 | 100,000 | +374 |
| 4 | 82,004 | 12,656 | 94,660 | 100,000 | -5,340 |
| 5 | 82,004 | 6,542 | 88,546 | 100,000 | -11,454 |
| Total | 410,020 | 89,979 | 499,999 | 500,000 | – |
Example: 5-year lease with 100,000 annual payments at 7% discount rate. Total expense is the same. Only the timing changes.
For detailed guidance on lease liability measurement, right-of-use asset calculation, discount rates, and journal entries, see our IFRS 16 guide. The mechanics are the same.
Lessor Accounting
Lessor accounting under FRS 102 has not changed significantly. Lessors continue to classify leases as either finance leases or operating leases:
- Finance leases: The lessor derecognises the asset and recognises a lease receivable at the net investment in the lease. Interest income is recognised over the lease term.
- Operating leases: The leased asset remains on the lessor's balance sheet. Lease payments are recognised as rental income on a straight-line basis over the lease term.
For detailed guidance, see our lessor accounting guide.
Financial Statement Impact
Bringing operating leases onto the balance sheet has a ripple effect across your financial statements. Understanding these impacts is essential for communicating with stakeholders.
Balance Sheet
- Total assets increase (new ROU assets)
- Total liabilities increase (new lease liabilities, split between current and non-current)
- Equity decreases at transition (cumulative adjustment)
- Ratios such as debt-to-equity and return on assets are affected
Income Statement
- The single "rent expense" line is replaced by depreciation and interest expense
- Total expense is front-loaded in early years of a lease
- EBITDA improves because lease costs are replaced by depreciation and interest, both excluded from this metric
Cash Flow Statement
| Category | Previous Treatment | New Treatment |
|---|---|---|
| Lease payments | Operating cash outflows (rent) | Split: principal (financing) + interest (operating) |
| EBITDA | Lower | Higher (no lease cost deduction) |
| Operating cash flow | Lower | Higher |
| Financing cash flow | Not impacted | Lease repayment outflows increase |
Communicate Early
The same cash is flowing out the door, but it shows up differently in your accounts. If your board, lenders, or funders aren't expecting the shift, it can lead to confusion. This is particularly important for loan covenants based on EBITDA or net debt metrics. Prepare stakeholders early and adjust how you present your numbers.
Transition
Transitioning to the new Section 20 requires careful planning, but the FRC has provided practical reliefs to simplify the process.
Transition Method
FRS 102 requires the simplified (modified retrospective) approach for transition:
Simplified Approach (Modified Retrospective)
Equivalent to IFRS 16's modified retrospective method. The cumulative effect is recognised as an adjustment to equity at the date of initial application, without restating comparative periods. Several practical expedients are available to simplify the process.
The difference between the ROU asset and the lease liability at transition is recognised as an adjustment to equity, not through the income statement. This applies only to leases that were previously classified as operating leases for lessees.
For a detailed walkthrough of the transition process, including practical expedients and worked examples, see our FRS 102 Transition Guide.
Disclosure Requirements
Under the revised Section 20, lessees must disclose key information about their lease arrangements in the annual financial statements. The most significant disclosures include:
- The total value of right-of-use assets by class of underlying asset
- Additions to right-of-use assets during the period
- The carrying amount of lease liabilities
- Interest expense on lease liabilities
- Depreciation charge for right-of-use assets
- Expense for short-term leases and low-value leases (where exemptions are applied)
- Total cash outflow for leases during the period
- A maturity analysis of lease liabilities showing undiscounted future payments
The maturity analysis and movement schedules for both the lease liability and right-of-use asset are typically where the most significant preparation effort is required.
For detailed disclosure guidance, see our IFRS 16 disclosure requirements guide. The principles are closely aligned. Where FRS 102 differs, see our FRS 102 vs IFRS 16 comparison.
This article is provided for general informational purposes only and does not constitute accounting, legal or professional advice.
Detailed Guidance
The measurement and accounting mechanics under FRS 102 Section 20 are closely aligned with IFRS 16. For detailed guidance on specific topics, our IFRS 16 guides cover the technical detail:
Lease Liability
Initial and subsequent measurement, including which payments to include and how to calculate present value.
Right-of-Use Asset
Initial measurement, depreciation, and adjustments for incentives and dilapidation provisions.
Discount Rates & OBR
Practical guide to determining the obtainable borrowing rate, including methods for entities without a credit rating.
Modifications & Terminations
How to account for changes to lease terms, payments, or early exits mid-way through a lease.
Journal Entries
Complete worked examples of lease accounting entries from commencement through to termination.
Remeasurement
When and how to remeasure the lease liability and adjust the right-of-use asset.
Note: These IFRS 16 guides apply equally to FRS 102 Section 20. The principles, calculations, and journal entries are the same. Where there are differences (such as terminology or specific exemptions), we note them in our FRS 102 vs IFRS 16 comparison.