!

Warning

The content on this page has been converted from PDF to HTML format using an artificial intelligence (AI) tool as part of our ongoing efforts to improve accessibility and usability of our publications. Note:

• No human verification has been conducted of the converted content.
• While we strive for accuracy errors or omissions may exist.
• This content is provided for informational purposes only and should not be relied upon as a definitive or authoritative source.
• For the official and verified version of the publication, refer to the original PDF document.

If you identify any inaccuracies or have concerns about the content, please contact us at [email protected].

FRS 102 Factsheet 11 - Lease accounting for lessees

This factsheet has been prepared by FRC staff to aid preparers in applying the lessee
requirements of Section 20 Leases of FRS 102. It should not be relied upon as a definitive
statement on the application of the standard nor is it a substitute for reading the detailed
requirements of FRS 102.

The FRC does not accept any liability to any party for any loss, damage or costs howsoever arising,
whether directly or indirectly, whether in contract, tort or otherwise from any action or decision
taken (or not taken) as a result of any person relying on or otherwise using this document or arising
from any omission from it.

This document contains copyright material of the IFRS® Foundation (Foundation) in respect of
which all rights are reserved.

No rights are granted to third parties other than as permitted by the Terms of Use
(www.frc.org.uk/FRStermsofuse) without the prior written permission of the FRC and the
Foundation.

Material issued in respect of the application of Financial Reporting Standards in the UK and the
Republic of Ireland has not been prepared or endorsed by the International Accounting Standards
Board.

© The Financial Reporting Council Limited 2024

The Financial Reporting Council Limited is a company limited by guarantee.
Registered in England number 2486368. Registered Office:
8th Floor, 125 London Wall, London EC2Y 5AS

[TOC]

## 1. Introduction {: #section-1-introduction }

Section 20 Leases was completely rewritten as part of the Periodic Review 2024, with the changes
effective from 1 January 2026.

The changes, based on the principles of IFRS 16 Leases, remove the distinction between operating
leases and finance leases for lessees, with the result that more leases will now require the
recognition of a right-of-use asset and a lease liability on the balance sheet. This method of
accounting is very similar to previous finance lease accounting.

The operating lease and finance lease distinction remains in place for lessors. Whilst the lessor
requirements have been rewritten, in many cases the accounting under the new requirements will
not differ significantly from that under the previous requirements[^1].

This factsheet has been prepared to provide an overview of key aspects of the new lease
accounting requirements from the perspective of lessees.

The recognition, measurement and presentation requirements of the revised Section 20 are
applicable to all entities applying FRS 102, including those that are in scope of Section 1A Small
Entities.

### Scoping

Section 20 applies to arrangements that meet the definition of a lease – ‘A contract, or part of a
contract, that conveys the right to use an asset (the underlying asset) for a period of time in
exchange for consideration'.

There are some situations where a contract that is, or contains, a lease will not be in scope of
Section 20, as set out in paragraph 20.1.

There may also be contracts which do not have the legal form of a lease, but which do in substance
meet the definition of a lease, and would therefore be in scope of Section 20. For example, a
contract could in substance convey the right to control the use of an identified asset, even if the
contract doesn't have the legal form of a lease and the asset is not explicitly specified. Preparers will
wish to satisfy themselves that they have identified all relevant contracts.

## Presentation and disclosure

This factsheet does not provide guidance on the presentation or disclosure requirements of
Section 20. Presentation requirements are set out in paragraphs 20.74 and 20.75 (for lessees)
and 20.113 (for lessors); entities will also need to consider the relevant requirements of company
law. Disclosure requirements are set out in paragraphs 20.76 to 20.85 (for lessees) and 20.114 to
20.121 (for lessors); other general disclosure requirements of FRS 102 may also be relevant in some
circumstances.

## 2. Recognition exemptions {: #section-2-recognition-exemptions }

Generally, the revised Section 20 requires a lessee to recognise all leases
on-balance sheet. However, one of the key elements of the revised Section 20 is the
existence of recognition exemptions for short-term leases and leases for which the
underlying asset is of low value. These are only exemptions from the requirement
to recognise a lease on the balance sheet – other requirements of Section 20, such
as the disclosure requirements, still apply. (20.5)

These exemptions permit lessees to leave eligible leases off the balance sheet and
recognise them in a similar manner to operating leases in the previous version of
Section 20 (i.e. recognise the expense on a straight-line basis or another systematic
basis that is more representative of the pattern of the lessee's benefit). (20.6)

Application of these recognition exemptions is voluntary – if a lessee wishes to, it
may recognise all its leases on-balance sheet.

### Short-term leases

A short-term lease is one that, at the commencement date, has a lease term (as
defined) of 12 months or less, and does not contain a purchase option. This
recognition exemption must be applied by class of underlying asset. (Glossary)

The assessment of the lease term is discussed in section 4 of this factsheet. It
includes whether the lessee is reasonably certain to exercise an extension option, or
reasonably certain not to exercise a termination option. (20.38)

### Leases for which the underlying asset is of low value

The value of an underlying asset is considered in absolute terms, independent of an
entity's materiality or the value of the lease payments. There is no limit to the
number of individual assets that can be considered as low-value for the purpose of
this recognition exemption. (20.9)

Section 20 does not specify a particular value threshold. Instead, it provides a list of
examples of asset types that are not of low value, including real estate and motor
vehicles. It is not exhaustive, and preparers need to consider whether a leased asset
is of similar value to those on this list. The purpose is to ensure that leases of
significant assets are recognised on a lessee's balance sheet, whilst allowing leases
of other, lower-value, assets to be left off-balance sheet. (20.11)

This recognition exemption can be taken on a lease-by-lease basis. However:
*   A lease cannot qualify as a lease of a low-value asset if the lessee subleases, or
    expects to sublease, the leased asset. (20.7, 20.12)
*   The recognition exemption can only be taken if the lessee can benefit from use
    of the underlying asset on its own or together with other resources that are
    readily available to the lessee, and the underlying asset is not highly dependent
    on, or highly interrelated with, other assets. (20.10)

This means that it is not possible to keep a lease off-balance sheet simply by
breaking the leased asset down into low-value components.

The low-value recognition exemption is intended to be more permissive than the
equivalent exemption in IFRS 16 (i.e. the threshold for 'low-value' is higher than in
IFRS 16, which does not state a threshold in the standard itself but indicates a
figure in the Basis for Conclusions). This is a key element of making the Section 20
changes proportionate for FRS 102 preparers. The Basis for Conclusions to FRS 102
also notes that low-value assets can include 'tablet and personal computers, small
items of office furniture and telephones'; this is also not an exhaustive list. (B20.8 to B20.11)

## 3. Identifying a lease {: #section-3-identifying-a-lease }

A contract is, or contains, a lease if the contract conveys the right to **control the
use of an identified asset for a period of time in exchange for consideration**. (20.15)

This assessment is made at the inception date of the contract[^2], and is only
re-assessed if the terms and conditions of the contract are changed. (20.15, 20.18)

### Identified asset

For a lease to exist, there must be an identified asset (the underlying asset). (20.15; Glossary)

### Specification of an asset

An asset may be specified explicitly in a contract: (20.19)
-   for example, the contract may specify a building by its address or a car by its
    registration number.

However, an asset may also be specified implicitly at the time it is made available
for use by the customer:
-   for example, the specific item of railway rolling stock which is delivered to
    the customer on the commencement date of the contract.

### Substitution rights

However, even if an asset is specified, there is no identified asset if the supplier has
a substantive right to substitute the asset throughout the period of use. If there is
no identified asset, there is no lease. (20.20)

A supplier's right to substitute the asset is substantive if it:
a) has the practical ability to substitute alternative assets throughout the
    period of use; and
b) would benefit economically from doing so.

Substitution rights are evaluated based on facts and circumstances at the inception
date. If the customer cannot readily determine whether the supplier has a
substantive substitution right, the customer shall presume that it does not. (20.21)

### Portions of an asset

A portion of an underlying asset can be an identified asset if it is physically distinct: (20.22)
for example, a floor of a building. However, a portion of an underlying asset that is
not physically distinct (e.g. a percentage of the capacity of a fibre optic cable) is not
an identified asset unless the portion is substantially all of the overall capacity of
the underlying asset.

### Right to control the use

For a lease to exist, the customer must, throughout the period of use, have both: (20.16)
*   the right to direct the use of the identified asset; and
*   the right to obtain substantially all the economic benefits from that use.

#### Right to direct the use

For the customer to have the right to direct the use of the identified asset, either: (20.25)
*   the customer must have the right to direct how and for what purpose the asset is
    used, throughout the period of use, in a manner that affects the economic
    benefits derived from its use; or
*   the relevant decisions about how and for what purpose the asset is used must be
    predetermined, and either:
    *   the customer has the right to operate the asset (or direct others to
        operate the asset in a manner that it determines) throughout the period
        of use, without the supplier having the right to change those instructions;
        or
    *   the customer designed the asset (or specific aspects of the asset) in a
        way that predetermines how and for what purpose it will be used
        throughout the period of use.

#### Right to obtain economic benefits from use

A customer can obtain economic benefits from the use of an asset directly or
indirectly many ways, such as by using, holding or subleasing the asset. (20.23)

The economic benefits from use of an asset include, but are not limited to, its
primary output and its by-products (or potential cash flows derived from them).

An entity considers the economic benefits that result from use of the asset within
the defined scope of a customer's right to use the asset. (20.24)

Economic benefits resulting from use of the asset outside the defined scope of the
customer's right to use the asset do not necessitate that there is no lease.

### Separating components of a contract

A contract may contain multiple components, of which some may relate to the
lease of an asset and others may relate to non-lease elements such as services
(e.g. maintenance of the leased asset). (20.27)

The consideration in the contract is allocated to each lease component on the basis
of the relative stand-alone price of each lease component and the aggregate
stand-alone price of the non-lease components. (20.31)

#### Separating lease components from other lease components

In identifying separate lease components, the right to use an underlying asset is a
separate lease component if the lessee can benefit from the use of the underlying
asset on its own or together with other readily available resources, and the
underlying asset is neither highly dependent on nor highly interrelated with other
underlying assets in the contract. (20.29)

Otherwise, the right to use multiple underlying assets may represent a single
combined lease component.

#### Separating lease components from non-lease components

Lease and non-lease components are accounted for separately unless the lessee
applies the practical expedient in paragraph 20.33. (20.28)

The practical expedient allows a lessee to elect, by class of underlying asset, not to
separate lease components from non-lease components, and instead account for
each lease component and any associated non-lease components as a single lease
component. (20.33)

#### Non-exchange components

The standard provides guidance when a lease provides a lessee with incoming
resources arising from a government grant or, for a public benefit entity, a
non-exchange transaction. (20.35)

#### Example 1

An entity enters into a contract to lease two identical lorries, with accompanying
maintenance services and insurance coverage, for total consideration of CU32,000.
The standalone price of leasing a lorry is CU14,000; the standalone selling price of
the maintenance services (per lorry) is CU4,000 and of insurance (per lorry) is
CU2,000. The lessee determines that the lease components meet the separability
criteria in paragraph 20.29.

The following table sets out the proportion of the total standalone price that relates
to each component, which is applied to the total contract consideration of
CU32,000 to determine the consideration for each component.

<div class="table-container" markdown="1">

| | Standalone price CU | % of total standalone price | Amount allocated to each component CU |
|:----------|---------------------:|-----------------------------:|--------------------------------------:|
| Lorry 1   | 14,000               | 35%                          | 11,200                                |
| Lorry 2   | 14,000               | 35%                          | 11,200                                |
| Non-lease | 12,000               | 30%                          | 9,600                                 |
|           | **40,000**           |                              | **32,000**                            |

</div>

If the lessee chose instead to apply the practical expedient in paragraph 20.33, it
would instead identify two lease components each with CU16,000 consideration
allocated.

### Intra-group arrangements

In intra-group situations it may be unclear whether or not a lease within the scope
of Section 20 exists. It is important to remember that the definition of a lease
requires a contract to exist: an agreement that creates enforceable rights and
obligations. Arrangements between group companies may or may not create
enforceable rights and obligations. This depends on the substance of those
arrangements, rather than their form.

This may have implications, for example, when multiple group companies occupy
different parts of a headquarters building for which one group company is the head
lessee. If an arrangement between the group companies does not create
enforceable rights and obligations between the head lessee and the other group
companies occupying the building, those occupiers may not be party to a lease and
hence may not be required to recognise a lease liability or right-of-use asset.

### Other considerations

A practical expedient allows an entity to apply Section 20 to a portfolio of leases
with similar characteristics, rather than separately to each individual lease. (20.13)

In certain circumstances, an entity is required to combine two or more contracts
and accounts for them as a single contract. (20.14)

## 4. Lease term {: #section-4-lease-term }

The term of a lease is the aggregate of: (20.38)
*   the non-cancellable period of the lease;
*   periods covered by an extension option that the lessee is reasonably certain to
    exercise; and
*   periods covered by a termination option that the lessee is reasonably certain not
    to exercise (or that can only be exercised by the lessor).

(As a result, when a lessee is able to choose between a shorter or a longer period,
the lease term is the shorter period unless the lessee is reasonably certain to
choose the longer period.) (20.40)

The lease term begins at the commencement date[^3] and therefore includes any
rent-free period. (20.37)

### Assessing the non-cancellable period

In assessing the length of the non-cancellable period, an entity determines the
period for which the contract is enforceable. (20.39)

A lease is no longer enforceable when the lessee and the lessor each have the right
to terminate the lease without permission from the other party, with no more than
an insignificant penalty.

### Assessing reasonable certainty

Both the lessee and the lessor assess, at the commencement date, whether the
lessee is reasonably certain to exercise extension options or reasonably certain not
to exercise termination options. (20.40)

The standard sets out a non-exhaustive list of factors to consider in this
assessment. These include the importance of the underlying asset to the lessee's
operations, and the significance of any leasehold improvements. It may also be
helpful to consider an entity's past practice in respect of similar assets. (20.41, 20.42)

### Reassessing reasonable certainty

Having made the assessment at the commencement date, a lessee only reassesses
whether it is reasonably certain to exercise its options in certain situations involving (20.43)
a significant event or a significant change of circumstances that is within the control
of the lessee.

### Revising the lease term

An entity shall revise the lease term if there is a change in the non-cancellable
period of a lease. Such a change could arise if, for example, the lessee exercises an
option not previously included in the determination of the lease term. (20.44)

#### Example 2

An entity enters into a contract to lease office space at a market rent. The initial
term is for 10 years and there is an option for the lessee to extend this for a further
5 years on similar terms. The entity expects to spend a significant amount on fitting
out the office space to meet its requirements, which is consistent with its approach
to previous leased offices. The entity's business is growing and profitable and it has
historically elected to extend other office leases.

The lessee concludes that the lease term is 15 years since remaining in the office
space confers an economic benefit (not having to fit out another office instead) and
it has past practice of extending leases in similar situations.

### Rolling leases

Entities may enter into so-called 'rolling leases' where there is no specified term or
end date and the lease is terminated when either the lessee or the lessor decides to
terminate it. An entity may also be party to a lease which automatically becomes a
rolling lease following an initial agreed contractual period.

In these situations, an entity needs to consider carefully for what period the lease is
enforceable, and what the non-cancellable period of the lease is (e.g. whether there
is a notice period that forms a non-cancellable element; or whether any economic
penalty from subsequent cancellation is more than insignificant).

As set out in Section 2 of this factsheet, if there is a lease term of 12 months or less,
the lease may be eligible for the recognition exemption for short-term leases.

### Landlord and Tenant Act 1954

The Landlord and Tenant Act 1954 (LTA) grants a statutory right to a new tenancy in
some circumstances once the current lease expires; entities will need to consider
any implications of this.

In particular, an entity needs to consider carefully whether or not occupation of a
property in relation to a lease that has expired and not (yet) been renewed
constitutes a lease (e.g. whether an enforceable contract exists), for what period the
lease is enforceable, and what the non-cancellable period of the lease is.

## 5. Measurement {: #section-5-measurement }

To measure its lease balances, a lessee must first calculate the lease liability, then
calculate the right-of-use asset.

### Measurement of the lease liability

Calculating the lease liability requires knowledge of:
*   Unpaid lease payments at the date of calculation; and
*   A suitable interest rate with which to discount these cashflows.

### Lease payments

The lease payments to be included in the measurement of the liability are: (20.51)
*   fixed payments (including in-substance fixed payments), less any lease incentives
    receivable;
*   variable lease payments that depend on an index or rate, initially measured using
    the index or rate as at the commencement date;
*   amounts expected to be payable by the lessee under residual value guarantees;
*   the exercise price of a purchase option if the lessee is reasonably certain to
    exercise that option; and
*   payments of penalties for terminating the lease, if the lease term reflects the
    lessee exercising a termination option.

### In-substance fixed lease payments

These are payments that may, in form, contain variability, but are in substance
unavoidable. For example, a payment that is contingent on the occurrence of an
event that has no genuine possibility of not occurring, is in substance a fixed
payment. Payments which initially contain variability can become in-substance fixed
payments when the variability is resolved. (20.52)

### Variable lease payments that depend on an index or a rate

Examples of such payments include those linked to a consumer price index, to a
benchmark interest rate or to reflect changes in market rents. (20.53)

#### Example 3a

A lessee enters into a five-year property lease on 01/01/X1, with annual lease
payments of CU10,000 (paid in advance), a six-month rent-free period, and a cash
lease incentive of CU3,000 received at the start of the lease (as opposed to
receivable in the future). The lease also includes an additional turnover rent,
payable in arrears, of 5% of the sales made by the lessee using the leased property.

The lease payments to be reflected in the calculation of the lease liability are as
follows:

<div class="table-container" markdown="1">

| Date     | Lease payment CU |
|:---------|:-----------------|
| 01/07/X1 | 5,000            |
| 01/01/X2 | 10,000           |
| 01/01/X3 | 10,000           |
| 01/01/X4 | 10,000           |
| 01/01/X5 | 10,000           |

</div>

The turnover rent is a variable lease payment that does not depend on an index or
rate, and is therefore not included in the measurement of the lease liability.

The cash lease incentive of CU3,000 is not included in the calculation of the lease
liability, but is deducted from the cost of the right-of-use asset. The benefit of the
lease incentive is therefore recognised as reduced depreciation of the right-of-use
asset. (20.47(b))

#### Example 3b

A lessee enters into a three-year lease for a lorry, with monthly lease payments of
CU1,000 structured as a CU10 fixed payment and a CU990 variable payment that
becomes due if the lorry is proven to be capable of being driven at any point
during the lease term.

Whilst, in form, this payment is variable, it is judged that it has no genuine
possibility of not occurring, and so constitutes an in-substance fixed lease payment,
and is included in the measurement of the lease liability.

#### Example 3c

A lease contract states that the lease payment, which is set initially at a market
level, will increase every third year to align to market increases in rent. This is an
example of a variable lease payment that depends on an index or rate
(paragraph 20.53).

The initial measurement of the lease liability does not include any amount in
respect of the future market rent adjustment. The lease liability is measured initially
using the index or rate at the commencement date (paragraph 20.51(b)), and so
reflects the initial market-based lease payment, but does not reflect, or contain any
assumptions about, changes to the index or rate after that date (paragraph 20.54).

Subsequently, the lease liability is remeasured, in line with paragraph 20.68(b),
when there is a change in the cash flows resulting from a change in an index or
rate. A corresponding adjustment is made to the right-of-use asset, in line with
paragraph 20.56(b).

#### Example 3d

A lessee signs a ten year lease with annual payments of CU10,000 and a break
clause at five years, accompanied by a CU5,000 penalty if exercised. It assesses that
it is reasonably certain not to exercise the break clause; therefore the lease term is
ten years and the total lease payments are CU100,000.

### Discount rate

Having determined the lease payments to include in the measurement of the lease
liability, the lessee applies a discount rate to measure the lease liability at present
value.

In general, the discount rate for a given lease is determined at the commencement
date of the lease, and is not re-assessed other than for certain reassessments of the
lease liability (see paragraphs 20.66 and 20.69) and certain lease modifications (see
paragraph 20.71(c)). Such situations are discussed in the Subsequent measurement
of the lease liability section of this factsheet.

### Interest rate implicit in the lease

FRS 102 requires the lessee to discount the lease payments at the interest rate
implicit in the lease. This is the rate that results in: (20.49, Glossary)

the present value of:
*   the lease payments; and
*   the unguaranteed residual value

equalling the sum of:
*   the fair value of the underlying asset; and
*   any initial direct costs of the lessor.

The lessee is required to use this rate if it can be readily determined. [^4]

However, the standard acknowledges that in some cases the implicit rate may not
be readily determinable.

### Incremental and obtainable borrowing rates

If the interest rate implicit in the lease cannot be readily determined, the lessee has
a choice, on a lease-by-lease basis, of using either the lessee's incremental
borrowing rate or the lessee's obtainable borrowing rate. (20.49, Glossary)

The lessee's incremental borrowing rate for any given lease is the rate of interest
that the lessee would have to pay in order to borrow over a similar term, and with a
similar security, the 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 for any given lease is the rate of interest
that the 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.

Lessees will need to consider, for each lease, what an appropriate interest rate is.
They may also be able to apply the portfolio approach, which allows Section 20 to
be applied to a portfolio of leases with similar characteristics (e.g. a similar lease
term for a similar class of underlying asset in a similar economic environment). (20.13)

#### Example 4

A lessee enters into a five-year property lease on 01/01/X1, with annual lease
payments of CU10,000 (paid in arrears).

The lessee concludes that it cannot readily determine the interest rate implicit in
the lease. It chooses to determine its obtainable borrowing rate instead, and
taking into account a quote from its bank to borrow CU50,000 over a similar term
concludes that this is 7%.

The table below sets out the undiscounted and discounted cash flows.

<div class="table-container" markdown="1">

| Date     | Lease payment CU | Discount factor | Discounted amount CU |
|:---------|:-----------------|:----------------|:---------------------|
| 31/12/X1 | 10,000           | 1.070           | 9,346                |
| 31/12/X2 | 10,000           | 1.145           | 8,734                |
| 31/12/X3 | 10,000           | 1.225           | 8,163                |
| 31/12/X4 | 10,000           | 1.311           | 7,629                |
| 31/12/X5 | 10,000           | 1.403           | 7,130                |
|          | **50,000**       |                 | **41,002**           |

</div>

The lessee therefore recognises a lease liability of CU41,002 at the commencement
date.

### Public benefit entities: Deposit rate

A public benefit entity that is unable readily to determine either the interest rate
implicit in the lease, or the lessee's incremental or obtainable borrowing rate for a
lease, shall use the rate of interest otherwise obtainable by the public benefit entity
on deposits held with financial institutions. (PBE20.50)

### Subsequent measurement of the lease liability

After the commencement date, the lease liability is measured by increasing the
carrying amount for the interest expense on the lease liability, reducing the carrying
amount for the amount of lease payments made, and remeasuring the carrying
amount for the effects of any reassessment, lease modifications, and revised
in-substance fixed lease payments. (20.62, 20.63)

#### Example 5

Based on the fact pattern in example 4, a table can be constructed showing how
the lease liability unwinds over the lease term. The interest expense is equal to the
interest rate (7%) multiplied by the opening balance for the period.

The table below sets out how the lease liability unwinds over the lease term.

<div class="table-container" markdown="1">

| Date     | Opening balance CU | Lease payment CU | Interest expense CU | Closing balance CU |
|:---------|--------------------:|:-----------------|--------------------:|-------------------:|
| 31/12/X1 | 41,002              | (10,000)         | 2,870               | 33,872             |
| 31/12/X2 | 33,872              | (10,000)         | 2,371               | 26,243             |
| 31/12/X3 | 26,243              | (10,000)         | 1,837               | 18,080             |
| 31/12/X4 | 18,080              | (10,000)         | 1,266               | 9,346              |
| 31/12/X5 | 9,346               | (10,000)         | 654                 | 0                  |
|          |                     | **(50,000)**     | **8,998**           |                    |

</div>

In respect of the right-of-use asset, the initial balance would also be CU41,002
(assuming no other adjustments to be made in line with paragraph 20.47), which
would typically be depreciated on a straight line basis over the five year lease term.

The total expense recognised in profit or loss is therefore interest of CU8,998 plus
depreciation of CU41,002, which equals the total cash flows of CU50,000.

### Using spreadsheets for calculations

Discounting can be done in spreadsheets using a line-by-line approach for each
period or one of the inbuilt formulae. There are generally three such formulae – PV,
NPV and XNPV. It should be noted that PV assumes that the periodic cashflows are
identical and at the end of a period, NPV allows differing cashflows but only allows
them to be at the end of a period, and XNPV allows full flexibility over cashflow
amounts and timing. Care will be needed to ensure that appropriate formulae are
applied to appropriate inputs.

### Changes to lease accounting

Variable lease payments that were not included in the measurement of the lease
liability (e.g. turnover-based rentals) are recognised in profit or loss in the period in
which the event or condition that triggers those payments occurs. (20.64)

Otherwise, changes to the lease term, lease payments and other conditions of a
lease fall into two categories:
*   Changes within the existing terms and conditions of a lease – referred to as
    reassessment of the lease liability; and (20.65 to 20.69)
*   Changes to the terms and conditions of the lease – referred to as lease
    modifications. (20.70 to 20.73)

### Reassessment of the lease liability

Changes within the existing terms and conditions of a lease are approached as
follows:
*   A change in the lease term, or in the assessment of an option to purchase the
    underlying asset, results in remeasurement of the lease liability using a revised
    discount rate. (20.66)
*   A change in the amounts expected to be payable under a residual value
    guarantee, or a change in future lease payments resulting from a change in an
    index or a rate used to determine those payments (for example a change to
    reflect changes in market rentals following a market rent review), results in
    remeasurement of the lease liability using an unchanged discount rate (unless
    the change in lease payments results from a change in floating interest rates, in
    which case a revised discount rate is used). (20.68)

A revised discount rate is used when there is a change in the underlying economics
of the lease.

### Remeasurement

The process for remeasuring a lease liability is the same as that set out in
Example 4, and any remeasurement of the lease liability results in an equivalent
adjustment to the right-of-use asset, with the condition that the right-of-use asset
cannot have a value less than zero (any excess in this case is recognised in profit or
loss). (20.65, 20.66, 20.68)

For a change in future lease payments resulting from a change in an index or a rate
used to determine those payments, remeasurement of the lease liability is triggered
only when there is a change in the cash flows (i.e. when the adjustment to the lease
payments takes effect). (20.68(b))

### Lease modifications

Lease modifications are approached as follows:
*   An increase in the scope of a lease (by adding the right to use one or more
    underlying assets), accompanied by a commensurate increase in the
    consideration for the lease, is treated as a separate lease. (20.70)
*   The lessee may use an unchanged discount rate instead of a revised discount
    rate to remeasure the lease liability if: (20.71, 20.72)
    *   the additional consideration is insignificant to the total consideration of the
        original lease;
    *   the scope of the lease is decreased by removing the right to use one or
        more underlying assets with a commensurate decrease in consideration; or
    *   the consideration payable is decreased for the remaining term of the lease
        but the scope of the lease is not decreased by removing the right to use
        one or more underlying assets.
*   For a lease modification not captured by the above criteria, the lessee uses a
    revised discount rate to remeasure the lease liability. (20.71)

### Remeasurement approach

For lease modifications that are not accounted for as separate leases, at the
effective date of the lease modification the lessee shall allocate the consideration in
the modified contract (applying paragraphs 20.31 to 20.35) and determine the lease
term of the modified lease (applying paragraphs 20.38 to 20.42). (20.71)

### Recognition of remeasurements

For lease modifications that decrease the scope of the lease, the lessee shall
recognise a proportionate reduction in the carrying amount of the right-of-use
asset to reflect the partial or full termination of the lease, account for any incoming
resources from a government grant or non-exchange transaction in the modified
lease, and recognise any resulting gain or loss in profit or loss. (20.73(a))

For all other lease modifications, the lessee shall make a corresponding adjustment
to the right-of-use asset, net of any adjustment for incoming resources from a
government grant or non-exchange transaction in the modified lease. (20.73(b))

### Measurement of the right-of-use asset

At the commencement date, a lessee shall measure the right-of-use asset at cost. (20.46)

The cost of the right-of-use asset is comprised of the initial measurement of the
lease liability as discussed above, adjusted for lease payments made prior to
commencement less any lease incentives received, and including initial direct costs
of the lessee, estimates of dismantling and removing the underlying asset
recognised in accordance with Section 21 Provisions and Contingencies, and any
amounts recognised in accordance with Section 24 Government Grants or
Section 34 Specialised Activities in respect of non-exchange transactions. (20.47)

Subsequently, a right-of-use asset is generally measured applying the cost model,
except that: (20.55, 20.60, 20.61)
*   the fair value model in Section 16 Investment Property is applied to right-of-use
    assets that meet the definition of investment property, unless applying the
    exemption for investment property rented to another group entity; and
*   if the lessee applies the revaluation model in Section 17 Property, Plant and
    Equipment to one or more classes of assets, it may also elect to apply the
    revaluation model to right-of-use assets relating to the same classes.

Under the cost model, the right-of-use asset is measured at cost less any
accumulated depreciation and accumulated impairment losses, and adjusted for
any remeasurement of the lease liability in accordance with paragraph 20.62(c). (20.56)

---

**Financial Reporting Council**
8th Floor
125 London Wall
London EC2Y 5AS
+44 (0)20 7492 2300

www.frc.org.uk

Follow us on
Linked in
or X @FRCnews

[^1]: One change for intermediate lessors to be aware of is in respect of classifying a sublease as a finance or an operating lease, as set out in paragraph 20.92. All else being equal, classifying a sublease by reference to the right-of-use asset arising from the head lease, rather than by reference to the underlying asset, is more likely to result in classification as a finance lease.
[^2]: The inception date is the earlier of the date of the lease agreement, and the date of commitment by the parties to the principal terms and conditions of the lease. This is not the same as the commencement date.
[^3]: The commencement date is the date on which the lessor makes the underlying asset available for use by the lessee. This is not the same as the inception date.
[^4]: Except on initial application of the revised Section 20 following the Periodic Review 2024 amendments - refer to Factsheet 9 - Initial Application of the Periodic Review 2024 amendments.

File

Name FRS 102 Factsheet 11 - Lease accounting for lessees

Publication date 26 November 2024

Type Information sheet

Format PDF, 291.1 KB

Download original