For accounting periods beginning on or after 1 January 2026 (with earlier application permitted), lessees applying FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland will generally recognise a right‑of‑use (ROU) asset and a lease liability, subject to available recognition exemptions.
Opening adjustments
When it comes to initial application of the new lease accounting requirements, the Periodic Review 2024 amendments do not allow for comparatives to be restated. Instead, the modified retrospective approach is taken, where the cumulative effect is recognised as an adjustment to opening retained earnings in the current period. In practice, most leases being brought onto the balance sheet will lead to adjustments to existing balances rather than resulting in an adjustment to opening retained earnings. Some of the more common circumstances are discussed below.
- Straight‑line accruals/prepayments and lease incentives arising from operating lease accounting under old FRS 102 (prior to the September 2024 edition). These will need derecognising on initial application of the amendments, with the other side of the journal adjusting the carrying amount of the ROU asset being recognised. The Technical Advisory Service’s Lease Accounting Initial Application helpsheet contains a worked example of accounting for these adjustments.
- Dilapidations/remediation provisions previously recognised in respect of operating leases. The ROU asset will not be adjusted and the provision will continue to be accounted for under Section 21 Provisions and Contingencies. However, for new leases being recognised after initial application, the ROU asset will be adjusted for such provisions. Preparers should refer to pages 37 and 51 of the Corporate Reporting Faculty’s Leases factsheet for further information.
Discount rates
The Periodic Review 2024 amendments have brought in changes to the discount rates which should be used when accounting for leases, including new terminology to familiarise ourselves with.
FRS 102 now requires that on initial application of the amendments, lease liabilities are discounted using either the lessee’s incremental or obtainable borrowing rate. Following initial application, lease liabilities relating to new leases will need to be discounted at the interest rate implicit in the lease, with the incremental or obtainable borrowing rates only used where the implicit rate cannot be readily determined. Those terms are defined as follows:
- Interest rate implicit in the lease: The rate of interest that causes the present value of the lease payments and the unguaranteed residual value to equal the sum of the fair value of the underlying asset and any initial direct costs of the lessor.
- Lessee’s incremental borrowing rate: 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.
- Lessee’s obtainable borrowing rate: 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.
Pages 30 and 31 of the Corporate Reporting Faculty’s Leases factsheet contain detailed guidance around determining these rates in practice.
Recognition exemptions and practical expedients
Seeking a proportionate approach for UK entities, the revised lessee model includes two recognition exemptions, which are expected to be widely used. These exemptions relate to short‑term leases (terms of 12 months or less) and leases of low‑value assets, both of which have the potential to not be quite as straight forward as you might first think.
Rolling leases are one area which could cause disparity in treatment, with discussion arising over whether or not leases with no defined end date automatically qualify as short‑term. A practical pitfall is assuming that the notice period equals the lease term without considering enforceability and renewal expectations. Even when contracts are drafted as one‑year agreements or shorter, lessees should still consider whether, in substance, the arrangement is expected to continue (for example, because the premises are integral to operations). Page 28 of the Corporate Reporting Faculty’s Leases factsheet contains further guidance around dealing with rolling leases.
Low‑value leases are also potentially challenging in some scenarios, with FRS 102 not explicitly defining what is meant by low value, nor does it provide a specified quantitative threshold. Instead, preparers will need to use and document their professional judgement. The low‑value assessment is based on the underlying asset, not the value of lease payments, and is assessed on an absolute basis rather than considering whether the lease is material to the lessee. FRS 102 does however give us a list of underlying assets which would not be considered low value, including vehicles, heavy machinery, and land and buildings; but this list is by no means exhaustive. Page 29 of the Corporate Reporting Faculty’s Leases factsheet contains further guidance.
Lease-related repairs, maintenance and improvements
As a starting point, lease liabilities are calculated based on the future lease payments, which are those relating to the right to use the underlying asset (including the exercise price of purchase options, and termination penalties, in certain cases). Importantly, lease payments do not include non-lease components such as a maintenance or service element for the underlying asset. The default position is that those non-lease components are excluded from the lease accounting and classified as operating expenses. However, there is a practical expedient available allowing entities to include those non-lease components within the lease accounting, resulting in front-loaded depreciation and interest costs. Preparers should refer to page 20 of the Corporate Reporting Faculty’s Leases factsheet for further information.
Leasehold improvements do not automatically become part of the ROU asset simply because they relate to a leased property. They are typically treated as the entity’s own assets (subject to the normal recognition considerations under FRS 102) and therefore treatment would not typically change with the application of the Periodic Review 2024 amendments.
Further help and resources
To discuss any of these common pitfalls and issues in more detail, or if you have a query about another aspect of applying the Periodic Review 2024 amendments, ICAEW members, students and affiliates can contact the Technical Advisory Service.
For further reading and more detailed guidance, preparers may wish to refer to the other resources available from ICAEW:
