The revised Section 20 is effective from 1 January 2026 and removes the operating-versus-finance lease distinction for lessees. Most leases now result in recognition of a right-of-use asset and a lease liability. The distinction broadly remains for lessors. The August 2026 technical update highlights the same fundamental change and its potential consequences for gearing and EBITDA.
The accounting is therefore only one part of the implementation project. Businesses also need to establish whether their lease population is complete, decide how long each lease runs for accounting purposes, determine appropriate discount rates and ensure subsequent changes are captured.
What changed under FRS 102 lease accounting in 2026?
Under the previous model, operating lease commitments were commonly kept off the balance sheet and rental expense recognised over the lease term.
For lessees applying revised Section 20, the starting point is now different. In general, a qualifying lease gives rise to:
- a right-of-use asset, representing the right to use the underlying asset; and
- a lease liability, representing the obligation to make lease payments.
This can increase reported assets and liabilities while replacing much of the former operating rental expense with depreciation and interest. The FRC notes that metrics including gearing, interest cover, current ratio and EBITDA may therefore change even though the underlying contractual cash payments have not. Covenant calculations can consequently require attention.
This is particularly important for businesses with substantial property, vehicle or equipment portfolios.
There are still recognition exemptions
The revised model does not mean literally every rental agreement must appear on the balance sheet.
FRS 102 provides voluntary recognition exemptions for qualifying short-term leases and leases of low-value underlying assets. A short-term lease has a lease term of 12 months or less at commencement and cannot contain a purchase option. The low-value assessment is based on the underlying asset itself rather than the reporting entity's materiality, and FRS 102 does not prescribe a single monetary threshold.
That distinction matters. A finance team should not create its own arbitrary “immaterial lease” exemption and assume it is the same thing as the standard's low-value exemption.
Which contracts are actually leases?
Before measuring anything, management needs to identify whether an arrangement contains a lease.
The contract must convey the right to control the use of an identified asset for a period of time in exchange for consideration. That means contracts labelled “service agreements” cannot automatically be excluded, while an agreement described commercially as a lease might fail the accounting definition in particular circumstances.
Management should therefore consider, among other matters:
- whether there is an identified asset
- whether the supplier has a substantive substitution right
- who directs how and for what purpose the asset is used; and
- who obtains substantially all of the economic benefits from its use.
This is an important completeness exercise. Looking only at the nominal ledger account called “rent” will rarely provide a robust lease population.
Intra-group arrangements also require care. There is no blanket accounting rule that every group occupation arrangement is a lease, nor an exemption simply because the parties are related. The question remains whether enforceable contractual rights and obligations exist. The FRC specifically addresses this issue in its lease factsheet.
Why lease term can be more difficult than the calculation
Once a lease has been identified, one of the most consequential judgements can be the lease term.
It comprises the non-cancellable period together with extension periods the lessee is reasonably certain to take and termination periods where it is reasonably certain not to terminate. Where the lessee genuinely has a choice between a shorter and longer period, the longer period is included only when the required reasonable-certainty threshold is met.
This makes break clauses and extension options important.
Suppose a business has a ten-year property contract with a break after year six. The existence of the break clause does not by itself make the accounting lease term six years. Management needs to consider the economic circumstances surrounding the decision.
Relevant evidence might include:
- the importance of the site to operations
- material fit-out or leasehold improvements
- relocation costs
- alternative premises available in the market
- contractual pricing compared with market terms
- previous behaviour for comparable sites; and
- business plans approved by management.
The conclusion should be evidence-led rather than simply reflecting a verbal intention to “probably stay”.
Rolling leases require separate thought
An arrangement renewed month by month for many years may look economically permanent, but historical continuity does not automatically create a long enforceable term.
The FRC states that rolling arrangements require consideration of the period for which the agreement is enforceable, including notice provisions and whether cancellation carries more than an insignificant penalty. Property-law rights can also affect the assessment.
Where those legal rights are unclear, this is an area in which accounting analysis may need legal input rather than an assumption from finance.
Measuring the lease liability
The initial lease liability is based on the present value of relevant future lease payments.
The payment population can include fixed and in-substance fixed payments, index- or rate-linked variable payments based on the index or rate at commencement, qualifying residual-value guarantees, certain purchase-option amounts and termination penalties where the lease term assumes termination. Other genuinely variable payments, such as some turnover-based amounts, are generally outside the initial liability.
Choosing the discount rate
FRS 102 requires the interest rate implicit in the lease where that rate can be readily determined.
If it cannot, the lessee may use, on a lease-by-lease basis:
- its incremental borrowing rate; or
- its obtainable borrowing rate.
The obtainable borrowing rate is an important FRS 102 simplification. Broadly, it considers the rate at which the lessee could borrow an amount similar to the undiscounted lease payments over a similar term.
That does not mean one company-wide rate should automatically be applied to every lease. Duration, economic environment and other characteristics may matter. A portfolio approach can, however, be appropriate where leases genuinely have similar characteristics.
What this means in practice for finance teams
The main implementation risk is treating revised Section 20 as a year-end spreadsheet calculation.
A business with dozens or hundreds of leases first needs reliable underlying data. Contract start dates, payment schedules, rent-free periods, incentives, break dates, indexation terms, purchase options and amendments all need to be captured.
That has consequences for several processes.
Lease registers. Existing fixed-asset or property schedules may not contain the required data.
Contract management. Finance may need information held by property, procurement, fleet or legal teams.
Month-end accounting. New leases and modifications need to reach finance promptly rather than being discovered during the audit.
Forecasting. EBITDA, interest, depreciation and balance-sheet forecasts may change.
Covenants. Agreements should be checked to establish whether ratios are defined by reference to frozen accounting policies or reported figures.
Company-size assessment. Because right-of-use accounting increases reported assets in many cases, businesses close to a balance-sheet threshold should model the interaction with the revised company-size limits rather than evaluating each regulatory change in isolation. The FRC confirms the potential increase in assets and liabilities under the revised lease model.
Transition into the new lease model
The transition provisions are deliberately different from a full comparative restatement.
For lessees, FRS 102 requires a modified retrospective approach: comparative information is not restated, with the cumulative effect recognised in opening equity at the date of initial application. The standard also contains transition practical expedients, including one concerning contracts previously assessed for the existence of a lease.
That makes the opening 2026 position particularly important. A clean reconciliation from the old lease commitments and accounting records into the new opening balances can be valuable both for management and for audit purposes.
Audit perspective: where scrutiny is likely to fall
Auditors may focus less on whether the spreadsheet adds up and more on the assumptions feeding it.
Areas likely to warrant attention include:
- completeness of the lease population
- identification of embedded leases within service arrangements
- evidence supporting break and extension decisions
- the basis for discount rates
- treatment of variable payments and incentives
- changes or modifications during the year
- data used in lease calculations
- transition entries; and
- adequacy of the financial statement disclosures.
Where a significant lease-term judgement changes the recognised liability materially, a management statement that the company “intends to stay” will generally provide a weaker audit trail than contemporaneous evidence such as approved plans, fit-out commitments, contractual analysis and commercial forecasts.
What should businesses do now?
- Build a complete contract population, not merely a list of accounts historically coded as rent.
- Identify exemptions deliberately and document the accounting basis for using them.
- Review break and extension clauses and retain evidence supporting significant lease-term judgements.
- Establish a discount-rate methodology that can be applied consistently to appropriate lease populations.
- Create controls for new leases and modifications so changes reach finance during the year.
- Model the impact on KPIs and covenants, particularly where balance-sheet or EBITDA measures matter.
- Prepare the transition reconciliation early rather than leaving opening balances until the year-end audit.
Conclusion
The FRS 102 lease accounting changes in 2026 move lease accounting from a largely expense-driven process into an area requiring contract analysis, valuation inputs and ongoing balance-sheet management.
For businesses with meaningful lease portfolios, the strongest implementation is therefore not simply a technically correct year-end calculation. It is a process that identifies contracts completely, captures changes promptly and leaves a clear audit trail for the judgements that drive the numbers.
Frequently asked questions
Do all leases have to go on the balance sheet under FRS 102 from 2026?
Generally most qualifying lessee leases do, but recognition exemptions are available for qualifying short-term leases and leases of low-value assets.
Is a lease break clause automatically the end of the lease term?
No. The accounting depends on whether the lessee is reasonably certain to exercise or not exercise the relevant option, based on the circumstances.
Can an FRS 102 company use its bank borrowing rate to discount leases?
Potentially. Where the implicit rate cannot readily be determined, FRS 102 permits an incremental borrowing rate or obtainable borrowing rate, subject to their respective definitions.
Are 2025 comparative figures restated for the new lease rules?
No for a lessee applying the transition provisions: comparative information is not restated.
Technical verification notes
Property-law conclusions concerning enforceability, statutory tenancy rights or unusual occupation arrangements should be reviewed on their specific facts rather than inferred from general accounting guidance.
Primary authority: FRC FRS 102 resources and factsheets · FRC lease accounting factsheet