Amendments to FRS 102: Lease Accounting

1. Introduction

1.1 Background

The Financial Reporting Council (FRC) has introduced significant amendments to FRS 102, effective from 1 January 2026. These changes aim to align UK standards with global norms, particularly IFRS 16, to improve transparency in lease accounting. The distinction between operating leases and finance leases for lessees has been removed, and a new unified accounting model is now in place. Most leases will now be recognised on the balance sheet, with both a right-of-use asset and a corresponding lease liability.

1.2 Purpose of Amendments

The primary goal of these amendments is to enhance comparability and consistency across financial reporting for leases. The changes will particularly affect lessees, who will need to adjust their accounting treatments to reflect leases on their balance sheet. The amendments also introduce exemptions for certain leases, such as short-term leases and leases of low-value assets.

2. Scope and Effective Date

2.1 Entities Affected

All entities applying FRS 102, including those that have leases on their balance sheets or those entering into new lease arrangements, will need to adopt the new provisions. The amendments apply to both small and large entities, with some exemptions available for certain types of leases.

2.2 Effective Date

The amendments will apply to accounting periods starting on or after 1 January 2026. Early adoption is allowed, provided that all amendments are adopted simultaneously.

2.3 Early Adoption

Early adoption is permitted, which allows entities to implement the amendments before the effective date, as long as the full package of changes is applied consistently across all leases.

3. Lessee Accounting

3.1 Identifying a Lease

Previously, FRS 102 required the classification of leases as either finance or operating leases. However, the new amendments remove this distinction, focusing instead on whether the contract contains a lease. A lease is defined as a contract that grants the right to control the use of an identified asset for a specified period in exchange for consideration. Lessees will need to determine if the contract conveys this right. The contract may include both lease and non-lease components, and each component must be accounted for separately.

3.2 Recognition Exemptions

• Short-term leases: Leases with a term of 12 months or less.
• Low-value leases: Leases involving assets that are considered low value, such as small office equipment or personal computers.

For these types of leases, lessees may continue to apply a simpler accounting model where they do not need to recognise a right-of-use asset and lease liability on the balance sheet. However, lessees using these exemptions will still be required to disclose relevant information about these leases.

3.3 Initial Recognition and Measurement

At the commencement of the lease, lessees must recognise:

• Lease Liability: The present value of future lease payments over the lease term.
• Right-of-Use Asset: Initially measured at cost, which includes the lease liability, any lease payments made to the lessor, less any incentives, and any initial direct costs incurred by the lessee.

This represents a significant change from previous standards, as most leases will now be recognised on the balance sheet, where previously operating leases were off-balance-sheet.

3.4 Subsequent Measurement

• Lease Liability: This liability will increase over time, reflecting the interest expense, and will decrease as lease payments are made.
• Right-of-Use Asset: The right-of-use asset will be depreciated over the lease term, and impairment tests will be required to ensure the carrying value of the asset does not exceed its recoverable amount.

3.5 Re-assessment of Lease Liability

Lessees must reassess the lease liability if there are changes to lease payments, such as a change in the index or rate used to determine the payments or if the lessee becomes reasonably certain to exercise an option, such as an extension or termination.

3.6 Lease Modifications

Lease modifications are changes to the scope or consideration of a lease that were not included in the original lease terms. These modifications could result in either the creation of a new lease or the modification of an existing lease, depending on the nature of the changes. When a modification occurs, lessees must assess whether it should be accounted for as a new lease or as part of the existing lease.

3.7 Disclosures

Lessees must disclose:

• A reconciliation of the movements in right-of-use assets during the period.
• A maturity analysis of lease liabilities.
• Information regarding any short-term and low-value leases, including their maturity analysis.
• Lease modifications and the impact on lease liabilities.

These disclosures are crucial for providing users of the financial statements with detailed information about a lessee's lease commitments.

4. Lessor Accounting

4.1 Classification and Recognition

Lessor accounting remains largely unchanged under the amendments. Lessors must classify leases as either:

• Finance Leases: When substantially all the risks and rewards of ownership are transferred to the lessee.
• Operating Leases: When the risks and rewards are not transferred.

The key change for lessors relates to subleases. If a lessor is both a lessee and a lessor for the same asset, the sublease must be classified with reference to the right-of-use asset, not the underlying asset.

4.2 Disclosures

• General information about leasing arrangements.
• A maturity analysis for finance leases.
• The net investment in finance leases.

These disclosures provide transparency into the lessor's lease activities and financial performance.

5. Sale and Leaseback Accounting

5.1 Key Principles

In a sale and leaseback transaction, entities must determine whether the transfer of an asset qualifies as a sale. If it does, the transaction will be treated as a sale, and the leaseback will follow the lease accounting rules.

5.2 Measurement Options

When the transaction qualifies as a sale, the seller-lessee must measure the right-of-use asset arising from the leaseback at:

• The proportion of the previous carrying amount of the asset relating to the retained right of use.
• Or, at cost, with any excess sale proceeds amortised over the lease term.

6. Transition Requirements

6.1 Lessees

Lessees must apply the amendments retrospectively, with the cumulative effect recognised as an adjustment to retained earnings at the beginning of the period in which the amendments are adopted. Lessees can apply practical expedients, such as:

• Using the previous operating lease commitments as the lease liability at the date of transition.
• Applying a single discount rate to a portfolio of leases with similar characteristics.

6.2 Lessors

Lessors need to reassess the classification of any subleases at the transition date. However, they are not required to make any other adjustments.

7. Key Differences between IFRS 16 and FRS 102 Section 20

• Low-Value Assets: FRS 102 allows more flexibility in determining what constitutes low-value assets compared to IFRS 16.
• Discount Rate: FRS 102 introduces the concept of the obtainable borrowing rate (OBR), simplifying the process for lessees in determining their discount rate.
• Lease Modifications: Section 20 of FRS 102 allows lessees to use an unchanged discount rate in certain modification scenarios, whereas IFRS 16 requires a revised discount rate for most modifications.
• IFRS 16 requires a lessor to disclose its risk management strategy for the residual interest in leased assets (for example, buy-back agreements or residual value guarantees). Section 20 does not require a similar disclosure.
• Maturity analysis: Section 20 also requires a lessee to disclose a maturity analysis of lease commitments for short-term leases and leases of low-value assets to which the optional recognition exemptions have been applied.