FRS102: New Lease Accounting Treatment
In March, the Financial Reporting Council (FRC) issued final amendments to FRS 102, specifically updating the accounting treatment of leases. These changes will take effect for accounting periods beginning on or after 1 January 2026, and they align FRS 102, Section 20 (Leases) more closely with IFRS 16, while maintaining a degree of flexibility for private entities.
On-Balance Sheet Lease Accounting
The most significant change under the new amendments is the elimination of the distinction between finance leases and operating leases. Previously, operating leases were often kept off the balance sheet. However, under the revised FRS 102, nearly all leases will be recognized on the balance sheet, reflecting the lessee’s right to use the asset and the associated liability.
Exceptions to the New Rules
While the new standard requires most leases to be recorded on the balance sheet, there are two notable exceptions:
Short-Term Leases: Leases with a term of 12 months or less, as determined at the commencement date, are exempt. However, if the lease includes an option to purchase the asset, it does not qualify as a short-term lease.
Leases of Low-Value Assets: Assets of low value can be excluded from on-balance sheet accounting. According to Paragraph 20.9 of the amendment, the assessment of an asset’s value is absolute, meaning the materiality of the lease to the lessee does not impact this determination. The value of lease payments is irrelevant to the classification of an asset as low value.
Criteria for Low-Value Assets
Paragraph 20.10 outlines two conditions that must be met for an asset to qualify as low value:
The lessee must be able to benefit from the asset either on its own or in conjunction with readily available resources.
The asset must not be highly dependent on or highly interrelated with other assets.
While the amendment does not provide specific examples of low-value assets, Paragraph 20.11 lists several assets that would not qualify, including vehicles (cars, vans, buses), heavy machinery (cranes, excavators), agricultural equipment (tractors, harvesters), boats, aircraft, and land and buildings. Furthermore, Paragraph 20.12 clarifies that if an asset is subleased or expected to be subleased, the head lease cannot be classified as a low-value asset.
The determination of what constitutes a low-value asset requires professional judgment and is entity-specific. Unlike IFRS 16, the FRC has opted not to define a monetary threshold for low-value assets, reflecting its more flexible approach.
Accounting Treatment
Under the new rules, lessees will recognize both the right-of-use asset and a corresponding lease liability on the balance sheet. Importantly, the amendments do not require a prior-year adjustment. Instead, the cumulative effect of initially applying the amendments will be recognized as an adjustment to the opening balance of retained earnings (or another equity component) on the date of initial application.
At the date of initial application, the lease liability is calculated as the present value of the remaining lease payments, discounted using either:
The lessee’s incremental borrowing rate: the interest rate the lessee would need to pay to borrow funds necessary to obtain an asset of similar value to the right-of-use asset in a similar economic environment.
The lessee’s obtainable borrowing rate: the interest rate the lessee would need to pay to borrow an amount similar to the total undiscounted lease payments to be included in the measurement of the lease liability.
Conclusion
The transition to the new lease accounting treatment under FRS 102 will likely require significant effort during the initial year of application. However, once implemented, the ongoing accounting should be more straightforward. These changes will increase transparency in financial reporting by ensuring that nearly all lease obligations are reflected on the balance sheet, providing a clearer picture of an entity’s financial position.