FRS 102 Changes (2026)

The Financial Reporting Council (FRC) updated FRS 102 to improve comparability with international standards and provide a more faithful representation of a company's lease obligations. The previous distinction between operating and finance leases created significant off-balance sheet liabilities that weren't visible to stakeholders.

• Improved transparency: Investors, lenders, and creditors see the full extent of lease commitments.
• Better comparability: Leasing versus buying decisions are more transparent in the accounts.
• International alignment: UK SMEs preparing for IFRS adoption (e.g., for overseas investors) have a closer starting point.

For lessees (you, the lease holder)

• On-balance sheet recognition: Most leases previously classified as "operating" (property, vehicles, equipment) must now be capitalised as right-of-use (ROU) assets with corresponding lease liabilities.
• Discounting required: Lease liabilities are measured at the present value of future payments, discounted using the rate implicit in the lease where that rate can be readily determined. Where it cannot, the lessee chooses, lease by lease, between its incremental borrowing rate (IBR) and its obtainable borrowing rate (OBR).
• Enhanced disclosure: Notes must explain the nature of the lessee's leases, a maturity analysis of the lease liabilities, and the key assumptions applied. Section 20 asks specifically for the types of discount rate used and the proportion of the total lease liability calculated using each type, rather than simply the rate applied to any one lease.
• Practical expedients remain: Short-term leases (≤12 months) and leases of low-value assets can still be expensed as incurred, but you must document the election. FRS 102 sets no monetary threshold for low value; see below.

Balance sheet

• Assets increase: ROU assets appear (often under "Tangible fixed assets" or a separate line). Initially measured at the present value of lease payments plus initial direct costs.
• Liabilities increase: Lease liabilities recognised for the discounted obligation. Split between current and non-current based on payment timing.
• Equity may change: Transition adjustments (e.g., cumulative catch-up method) can create a retained earnings adjustment. Ongoing depreciation and interest patterns differ from the old straight-line expense.
• Leverage ratios worsen: Debt increases; key covenants (e.g., net debt / EBITDA) may be affected. Lenders may require renegotiation or addbacks.

Profit & Loss

• Depreciation expense: ROU asset is depreciated (typically straight-line over the lease term). Replaces the previous rental expense line.
• Interest expense: Lease liability incurs interest using the discount rate. Interest is higher in early years (on the larger outstanding balance), lower later.
• Front-loaded expense: the total P&L charge (depreciation + interest) typically follows a more front-loaded profile than a straight-line rental: higher in the early years, declining after. For a simple lease, aggregate depreciation and interest broadly reconcile to the lease consideration over the term, so the main effect is on timing. Initial direct costs, incentives, restoration obligations and modifications all change that picture.
• EBITDA improves: rental expense (which reduces EBITDA) is replaced by depreciation (below EBITDA) and interest (below EBIT). Reported EBITDA usually rises, though profit may not. Check your facility documents before assuming this helps: covenant EBITDA is often defined separately, and may be frozen on the old basis or defined so that the improvement does not flow through.

Cash flow statement

• Cash flows are reclassified: repayments of the lease liability principal are classified as financing cash flows. The interest portion may be classified as either operating or financing, consistent with the entity's accounting policy for interest paid. Payments for short-term and low-value leases accounted for under the recognition exemptions remain operating cash flows.
• No overall cash impact: Total cash out the door is unchanged, just reclassified.

FRS 102 paragraph 20.49 requires lease liabilities to be discounted using the interest rate implicit in the lease where that rate can be readily determined. If it cannot, the lessee chooses, on a lease-by-lease basis, between its incremental borrowing rate (IBR) and its obtainable borrowing rate (OBR).

In many leases the implicit rate cannot readily be determined, because the lessee does not hold all the information needed to calculate it: the lessor's assumptions about residual value and its initial direct costs are not usually disclosed.

The FRC introduced the OBR as a simplification, taking the view that it is broadly similar in concept to the IBR but simpler for FRS 102 preparers to determine. That is why many UK SMEs find it the more practical of the two, though the choice remains yours and is made lease by lease.

OBR characteristics:

• Entity-specific: Reflects your company's credit risk, not a generic market rate.
• Term-matched: the definition refers to borrowing over a similar term, so a 5-year lease should use a 5-year borrowing rate, not a 1-year overdraft rate.
• Amount-referenced: the definition refers to borrowing an amount similar to the total undiscounted lease payments. Note that security appears in the definition of the incremental borrowing rate, not the obtainable borrowing rate.
• Market-grounded: the rate should represent borrowing pricing that would realistically be obtainable by this lessee, for borrowing of a similar term and amount. In estimating that, the features of the hypothetical borrowing and the entity's credit profile both affect the pricing a lender would offer.
• Evidenced: a rate that appears plucked from thin air is difficult to support if challenged. A transparent, documented methodology is not.

The discount rate is one of the more visible judgements in the accounts, so expect questions on it from your auditors or reporting accountants:

• How was the rate determined? An undocumented estimate is difficult to support if challenged. A documented approach is not.
• Is it entity-specific? An arbitrary spread not derived from the company's own credit profile is hard to evidence. A base rate plus spread approach works where the spread is entity-specific, documented, and grounded in the company's actual financial characteristics.
• Is it term-matched? Using a short-term borrowing rate (e.g., overdraft at 8%) for a 10-year property lease isn't appropriate.
• Where is the supporting evidence? A clear trail helps: source of the base rate, the credit adjustments, and the rationale. Lease Rater produces this as a PDF, though the standard prescribes no particular format.
• Is it consistent? Materially different rates across similar leases invite questions unless the difference can be explained.

Common audit challenges include rates that are:

• ❌ Too generic – "We used 5% because that's what our bank charges", with nothing recorded about the facility it came from or how it relates to this lease.
• ❌ Unsupported – No documentation of how the rate was derived or what it's based on.
• ❌ Inconsistent – Different rates for similar leases with no clear explanation.

FRS 102 allows two exemptions where you can continue to expense leases as incurred (like the old rules):

• Short-term leases: Lease term is 12 months or less (with no purchase option). Example: month-to-month office space, 6-month equipment rental.
• Low-value asset leases: a lessee may elect not to recognise a right-of-use asset and lease liability where the underlying asset is of low value. The assessment is made on an absolute basis, not by reference to what is material to your company. FRS 102 deliberately prescribes no fixed monetary threshold, one of the points where it is more permissive than IFRS 16. Instead it identifies categories that cannot be low value, including cars, vans, trucks and lorries, land and buildings, and production-line equipment. Tablets, personal computers, small items of office furniture and telephones are the kind of asset the exemption is aimed at.

Important: these are elections, not requirements, and they are made on different bases. The short-term exemption is elected by class of underlying asset, so it applies across that class. The low-value exemption may be elected lease by lease. Whichever you take, disclose the policy.

FRS 102 does not offer the choice of transition approaches that IFRS 16 does. There is one route, set out in the transition provisions in Section 1.

A lessee applying the Periodic Review 2024 amendments does not restate comparative information for the revised lease requirements (paragraph 1.47). Instead, the cumulative effect of applying the new requirements is recognised in opening retained earnings, or another appropriate component of equity, at the date of initial application. The comparative period continues to present operating and finance leases as it did before.

For leases previously classified as operating leases, the lease liability is generally measured at the present value of the remaining lease payments, discounted using the lessee's incremental borrowing rate or obtainable borrowing rate at the date of initial application (paragraph 1.51). The right-of-use asset is generally measured at an amount equal to that liability, adjusted for any prepaid or accrued lease payments. There is no need to rebuild the lease from its original commencement date.

FRS 102 also provides transition practical expedients, including:

• using a single discount rate for a portfolio of leases with reasonably similar characteristics;
• relying on an existing onerous-lease assessment in place of an impairment review, in certain circumstances;
• excluding leases whose term ends within 12 months of the date of initial application;
• using hindsight when determining the lease term where the contract contains options.

Entities that already calculate IFRS 16 lease balances for inclusion in IFRS group accounts may be able to use those carrying amounts directly, under the practical expedient in paragraph 1.48.

What this means for the discount rate: you need a rate for every in-scope lease as at the date of initial application, which is the start of your first affected period. The portfolio expedient above is worth knowing about if you have many similar leases.

• Credible, entity-specific OBRs in minutes, not weeks, without commissioning a bespoke study.
• A professional PDF report showing the rate, the range, the methodology and the key drivers, ready for your audit file or working papers.
• A transparent method: an observable base rate from the SONIA term structure, plus a credit-adjusted spread built from a four-pillar assessment covering financial strength, security and structure, sector and size, and exposure. Our Methodology & Regulatory Basis sets out the calibration in full.
• Repeatable and consistent: the same approach for every lease in the portfolio, across entities, periods and audit cycles.
• A defensible range rather than a single figure, so management can exercise judgement within it and say why.

If you are still deciding which rate to use, OBR or IBR sets out the choice; how to calculate an OBR walks through the steps by hand.

For each lease

• Lease agreement: Review the contract for term, payment amounts, timing (monthly/quarterly, in advance/arrears), renewal options, and any purchase options.
• Commencement date: When the lease started (or will start).
• Lease classification: Confirm whether it's eligible for practical expedients (short-term or low-value).

For your company

• Financial metrics: Latest filed accounts or management accounts. Lease Rater calculates 14 industry-standard metrics:
  • Profitability: EBITDA margin, EBIT margin, Return on Equity
  • Liquidity: Current ratio, quick ratio, cash ratio
  • Leverage: Total Debt/TNW, Total Debt/EBITDA, Net Debt/EBITDA
  • Coverage: Interest coverage ratio, fixed charge coverage
  • Cash flow: Free cash flow, FCF/total debt ratio
  • Balance sheet: Cash buffer
  If tax paid or capex not provided, these are estimated using industry-standard methods (19% tax rate, depreciation proxy for capex).
• Credit profile: Understanding of your company's financial strength (we guide you through a simple credit rating band selection).
• Sector & size: Industry classification and credit size band (derived from turnover).

The revised Section 20 applies to accounting periods beginning on or after 1 January 2026. That date has passed, so what matters is your year-end rather than the calendar:

• 31 December year-end. Your first affected period began on 1 January 2026 and is running now. You need a discount rate for every in-scope lease, plus transition adjustments as at 1 January 2026. The audit follows in the first half of 2027.
• Year-end falling in 2027. If your period began at any point during 2026, it is already an affected period and the same applies from that start date.
• Year-end still to come in 2026. If your current period began before 1 January 2026, these are your last accounts under the old rules. Your first affected period starts the day after this year-end, which is the balance sheet the transition adjustments attach to.

Two points that catch people out regardless of year-end. Any lease signed inside an affected period is accounted for under the new rules from the start; there is no grandfathering for new agreements. And the discount rate is needed twice over: once for the transition balance sheet, and again for the year itself.

The rate is easier to evidence before year-end than after it. At audit, the discount rate, the transition approach and the disclosures are all looked at, and that is the point at which the documentation either exists or it doesn't.

Do I need a different OBR for each lease?

Not necessarily. If you have multiple leases with similar terms (same duration, similar security, entered around the same time), you can use a single OBR. However, a 2-year vehicle lease and a 10-year property lease should have different OBRs (term mismatch). Document your approach and keep it consistent.

Does the disclosure note need every individual rate?

No, and it is worth separating two jobs that sound alike. The note explains which discount-rate types the entity applied across its portfolio and the proportion of the total lease liability calculated under each, along the lines of "the obtainable borrowing rate for leases representing 80% of total lease liabilities, the rate implicit in the lease for 15%, and the incremental borrowing rate for 5%". It does not list a rate lease by lease. Sitting behind those percentages is the evidence for the particular rate applied to a particular lease, and that belongs in the audit file rather than in the accounts. Lease Rater produces the second: the derivation, the range and the drivers for one lease, which is what a reviewer asks for when they test the figures underneath the note.

Can I use my bank's lending rate?

It can inform the rate, and evidence of your own actual borrowing is relevant. FRS 102 imposes no "formal rate letter" requirement. But the further your evidence sits from the lease in question, the more adjustment and judgement it needs: a facility over a different term, for a different amount, or agreed at a different time is not the rate for this lease without reasoning to bridge the gap. A verbal "we charge about 6% on term loans" with nothing recorded leaves you with little to point to. Lease Rater produces the reasoning and the documentation.

What if my company has no debt?

You still need an OBR. It's a hypothetical rate what you could borrow at if you went to a lender for a secured or unsecured facility matching the lease terms. Lease Rater builds this from your credit profile and market benchmarks even if you've never borrowed.

Do subsidiaries need separate OBRs?

If subsidiaries are separately financed or have materially different credit profiles, yes. If they're guaranteed by a parent or operate as a single economic entity, you can often use group-level OBRs. Consult your auditor on group accounting policies.

1. Inventory your leases – List all property, vehicle, equipment, and IT leases. Note terms, payment amounts, and commencement dates.
2. Assess exemptions – Identify short-term (≤12 months) leases by class, and low-value leases, that qualify for the recognition exemptions.
3. Generate OBRs – Use Lease Rater to calculate entity-specific, term-matched OBRs for in-scope leases. Download PDF reports for your working papers.
4. Model the impact – Work with your finance team or accountant to calculate opening balance sheet adjustments and assess covenant impacts.
5. Engage your auditor early – Share your approach, OBR methodology, and transition plan. Get buy-in before year-end.

Start your OBR calculations now

• FRC guidance: FRS 102 Section 20 (Leases) Official standard from the Financial Reporting Council.
• ICAEW: Search "FRS 102 leases" on icaew.com for member guidance and webinars.
• Lease Rater: How to Use guide explains the OBR calculation process step-by-step.