FRS 102 Periodic Review Series – Accounting for Leases

These are used by an estimated 3.4 million businesses in preparing their financial statements.

The amendments represent the largest revision of the standards since their launch in 2013. They aim to enhance the alignment of UK and Irish GAAP with International Financial Reporting Standards (IFRS).

All changes come into effect for periods beginning 1 January 2026. Early adoption will be permitted, provided all amendments are applied at the same time.

In this series of web articles, which will be published over the next few months, we will review each of the key changes, providing information on the new accounting and disclosure provisions, and how businesses can prepare for the changes.

This article outlines the new requirements for accounting for leases. Future articles will outline the revisions to the small companies’ regime, and other incremental GAAP changes. Our article on accounting for revenues from contracts with customers can be found [insert hyperlink].

Accounting for Leases 

Section 20 Leases has been completely rewritten to incorporate updates that were made to the corresponding International Financial Reporting Standard, effective from 1 January 2019. 

The premise of Section 20 is to bring the majority of leases onto the lessee’s balance sheet, including those previously accounted for as operating leases.  The accounting treatment for lessors is largely unchanged and therefore this article will only deal with the upcoming changes for lessee’s accounting and reporting requirements.

Application of section 20

Section 20 applies to any contract that contains a lease. A contract contains a lease if it conveys the right to control the use of an identified asset, in exchange for consideration, for a period of time. 

Where such a contract exists, the lessee will recognise a lease liability, being the present value of future lease payments. These payments will be discounted using the interest rate implicit in the lease, or, if this is not readily determinable, the lessee’s incremental borrowing rate. 

The rate implicit in the lease is the rate that causes the present value of future lease payments to equal the fair value of the underlying asset plus any direct costs of the lessor. The incremental borrowing rate is the rate of interest a lessee would have to pay to borrow the funds to purchase an equivalent asset over similar terms with similar security. 

Given these two rates may be difficult for an entity to calculate, FRS 102 offers a further simplification in that, if neither of these two rates are readily determinable, an entity may use the lessee’s obtainable borrowing rate to discount future lease payments. This is the rate that an entity would have to borrow, over a similar term, to obtain the same level of funds as total undiscounted lease payments. 

The lease liability may need to be adjusted for lease incentives, variable lease payments dependent on an index or rate, and amounts expected to be payable under residual value guarantees.

The lease liability is unwound over the life of the lease. The lease liability may need to be remeasured if certain lease modifications occur. 

A corresponding Right-of-Use (ROU) asset is recognised on the lessee’s balance sheet. The ROU asset is initially recognised at cost, being the amount of the initial measurement of the lease liability, adjusted for any lease payments made in advance of the commencement date, any lease incentives, any initial direct costs incurred, and any amounts recognised in respect of provisions or contingencies. 

Following initial recognition, a ROU asset may be accounted for at cost less depreciation and impairment, or using a revaluation method. Where the ROU asset meets the definition of investment property, any revaluation movements will be recorded in the profit and loss account; where the ROU asset meets the definition of property, plant and equipment, any revaluation movements will be recorded in a revaluation reserve through Other Comprehensive Income. The choice of measurement model must be applied consistently across assets within the same class. 

Recognition exemptions

There are two exemptions from the above lease treatment available.

The first is for short-term leases. A lease is short-term if, at commencement, the lease has a term of 12 months or less. The second exemption is for low-value assets. No monetary value is given in the section as a definition of a low-value asset; however, it is intended to apply to items such as mobile phones, laptops and photocopiers. The section is clear that the application of this principle is made on an absolute basis, regardless of whether the lease is material to the lessee. An asset that is subleased by a lessee cannot, by definition, be a low-value lease.

Where one of these exemptions is taken, the lessee continues to account for the lease as per the previous section 20; the cost of the lease is released to the profit and loss account on a straight-line basis over the lease term, or on another systematic basis that is more representative of the pattern of the lessee’s benefit. 

Initial application of the new section

The new accounting requirements are required to be applied using the modified retrospective method; that is, with no restatement of prior year comparatives, but any differences arising on transition taken to opening reserves of the current year. 

For leases that were previously classified as operating leases, a lessee will have to calculate and record a lease liability equalling the present value of the remaining outstanding payments on that lease, using one of the interest rates discussed above. A corresponding ROU asset will be recognised, based on the value of this lease liability. A lessee will need to consider whether any impairment is required of the ROU asset at initial recognition. 

For leases that were previously classified finance leases, a lessee shall use the carrying amount of the leased asset and lease liability immediately before the date of initial application.

Some practical expedients have been written into Section 1 Scope of the revised FRS 102 to assist with transition to the new requirements.

Disclosure requirements

The new section also includes more disclosures than are required under the previous version of FRS 102. 

In the year of transition only, disclosures will be required to explain the impact of adopting the new section, including any practical expedients taken and any impact to opening reserves as a result of transition. 

Henceforth, for each reporting period, an entity will be required to give specified qualitative and quantitative information surrounding its lease arrangements. Where relevant, this information could include any potential exposure not included in the measurement of the lease liability (such as variable lease payments, extension options and termination options), covenants or restrictions imposed, and types of discount rates used, including any judgements or estimates made in determining these.

For short-term or low-value leases, disclosure must be given of the expense relating to these leases. 

For ROU assets, reconciliations will be required, showing opening and closing carrying values, along with movements due to additions, disposals, impairments, revaluations and any other changes. These will need to be shown separately from other items of Property, Plant and Equipment. 

Impact on other accounting standards

FRS 101, Reduced Disclosure Framework, is based on the accounting principles contained within International Financial Reporting Standards, as adopted by the relevant jurisdiction. Therefore, IFRS 16 has applied to entities reporting under FRS 101 since 2019. 

FRS 105, The Financial Reporting Standard applicable to the Micro-entities Regime, has not been updated for the changes to lease accounting. Preparers of financial statements under FRS 105 should continue to use the former accounting treatments.

Preparing for the changes

In anticipation of the amendments to FRS102, entities should review their existing, and anticipated, lease agreements to determine whether they fall within the scope of Section 20, and whether any recognition exemption is available to them.

Significantly, as the application of the Standard may create additional assets and liabilities on the face of the balance sheet, management should be aware of any financing covenants that may be impacted by a change in gearing or other ratios. In these circumstances, discussion with finance providers in advance of the changes is advisable. 

For further information, and to find out how Grant Thornton can assist you in navigating these changes, please contact Louise Kelly, Partner.