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 either the rate implicit in the lease (if readily determinable) or an entity-specific obtainable borrowing rate (OBR).
• Enhanced disclosure: Notes must explain the nature of leases, maturity analysis, and key assumptions (including the discount rate used).
• Practical expedients remain: Short-term leases (≤12 months) and low-value asset leases (typically ≤£5,000) can still be expensed as incurred, but you must document this choice.

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: Total P&L charge (depreciation + interest) is higher in year 1 than a straight-line rental would have been, then declines. Over the lease life, total expense is the same, but timing differs.
• EBITDA improves: Rental expense (which reduces EBITDA) is replaced by depreciation (below EBITDA) and interest (below EBIT). EBITDA looks better, but profit may not.

Cash flow statement

• Operating cash flows improve: Lease payments previously in "operating activities" are now split: the interest portion stays in operating; the principal repayment moves to "financing activities."
• No overall cash impact: Total cash out the door is unchanged, just reclassified.

FRS 102.20.9 requires lessees to discount lease payments using the rate implicit in the lease if readily determinable. In practice, lessors rarely disclose their implicit rate, residual values, profit margins, and assumptions are proprietary.

When the implicit rate is not available (the norm), FRS 102 permits use of either an incremental borrowing rate (IBR) or obtainable borrowing rate (OBR). For UK SMEs, the OBR is the practical choice:

OBR characteristics:

• Entity-specific: Reflects your company's credit risk, not a generic market rate.
• Term-matched: Aligned to the lease duration (e.g., a 5-year lease should use a 5-year borrowing rate, not a 1-year overdraft rate).
• Security-reflective: Accounts for whether the lease is secured by the underlying asset (like an asset-backed loan) or unsecured.
• Defensible: Auditors will challenge rates that appear plucked from thin air. You need a transparent, evidenced methodology.

Your auditors (or reporting accountants) will focus heavily on the discount rate. Expect them to ask:

• How was the OBR determined? "We guessed 5%" won't pass muster. You need a documented approach.
• Is it entity-specific? A generic rate (e.g., Bank of England base rate + arbitrary spread) isn't compliant. The rate must reflect your credit profile.
• 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's the supporting evidence? Auditors need a clear audit trail: source of base rate, credit adjustments, rationale. A professional PDF report with methodology is ideal.
• Is it consistent? If you have multiple leases, using wildly different OBRs without justification will raise red flags.

Common audit challenges include rates that are:

• ❌ Too generic – "We used 5% because that's what our bank charges" (but no formal rate letter or entity-specific analysis).
• ❌ 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: The underlying asset, when new, has a low value (typically £5,000 or less). Example: office printers, small IT equipment, coffee machines. This is based on the asset's absolute value, not materiality to your company.

Important: These are elections, not requirements. You must apply them consistently and disclose your policy. You can't cherry-pick (e.g., capitalise some low-value leases and not others without a clear rationale).

When you first adopt FRS 102 (2026) for periods beginning on or after 1 January 2026, you have two main approaches:

1. Full retrospective approach

• Restate prior year comparatives as if the new rules had always applied.
• More complex, but provides the cleanest comparison.
• Requires recalculating lease liabilities and ROU assets from lease commencement dates.

2. Modified retrospective approach (simplified)

• No restatement of prior year comparatives.
• Recognise a cumulative catch-up adjustment in opening retained earnings on 1 January 2026.
• Measure ROU asset equal to lease liability (adjusted for prepayments/accruals), avoiding complex historical calculations.
• Most SMEs will choose this.

Key decision: You'll need OBRs for all in-scope leases as at the date of initial application (1 January 2026 or later, depending on your year-end).

• Credible, entity-specific OBRs in under 2 minutes. No waiting weeks for a bespoke accountancy firm study.
• Professional PDF report showing the rate, range, methodology, and key drivers ready for your audit file or working papers.
• Transparent methodology: Base rate (SONIA term structure) + credit-adjusted spread from a four-pillar spread framework weighted by predictive power:
  1. Financial Health (45% weight): 14 metrics assess profitability, liquidity, leverage, coverage, and cash flow. Dominant weight because financial strength is most predictive of default risk.
  2. Security/Structure (30% weight): Collateral quality (fixed charge vs floating charge vs unsecured), payment profile, rent deposits, years trading, external credit rating.
  3. Sector & Size (15% weight): Industry-specific risk premiums and company scale adjustments.
  4. Exposure (10% weight): Lease size relative to company capacity (loan-to-EBITDA, facility-to-revenue, facility-to-TNW).
  Auditors can see how the rate was built.
• Repeatable & consistent: Apply the same rigorous approach to every lease in your portfolio. Supports consistency across entities, periods, and audit cycles.
• No subscriptions or onboarding. Pay per use (£49-£99 per OBR) or bulk packs for portfolio work.

Calculate your OBR now   See how it works

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 company size band (micro/small/medium/large per UK definitions).

• Now (Q4 2025): Review your lease portfolio. Identify which leases are in scope (vs short-term/low-value exemptions). Prepare financial data. Decide on transition approach.
• Q1 2026: For calendar year-end companies, the new rules apply to periods beginning 1 January 2026. You'll need OBRs ready for transition accounting (opening balance sheet adjustments).
• Throughout 2026: Any new leases signed during 2026 must be accounted for under the new rules immediately (no grandfathering).
• Year-end audit (2026/27): Auditors will review your discount rates, transition approach, and disclosures. Having professional OBR documentation is critical.

Don't leave it until year-end. Generate your OBRs now so your finance team can model the impact and plan ahead.

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.

Can I use my bank's lending rate?

Only if you have a formal rate letter or facility agreement that matches the lease term and security profile. A generic "we charge 6% on term loans" from your relationship manager won't suffice and auditors need formal documentation. Lease Rater provides that 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) and low-value (≤£5,000) leases that qualify for practical expedients.
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.