The revised FRS 102 brings almost all leases onto the balance sheet, and for most finance teams the hardest part is not the theory – it is the legwork of finding every lease, capturing the right details, and turning them into calculations your auditor will accept. The key to a smooth transition is getting these fundamentals right early.
This guide is the practical “how to”, if you first want to understand what is changing and how the accounting works, start with our comprehensive technical guide to FRS 102 and leases, then come back here to put it into practice.
Build and maintain a complete register of leases
1. Start with your contracts
One of the biggest issues we see is businesses working from an incomplete log of their leases. Most finance teams have a good handle on the obvious ones, but it is easy to miss leases, particularly in larger businesses or those that regularly enter into lease-type arrangements.
A good starting point is a list of signed contracts. These often relate to:
- Property
- Vehicles
- Equipment
- IT hardware or infrastructure
- Warehousing or logistics arrangements
Don’t forget to check for any side agreements or modifications to the original lease.
2. Go beyond the finance function
In many businesses, the majority of leases sit outside finance altogether. To build a complete picture, talk to your wider teams – for example operations, procurement and IT. While you are there, set up a simple process so that any new lease is flagged to finance at the point it is entered into, ready to be added to the central register.
3. Check whether it is actually a lease
A common sticking point is determining whether a contract genuinely contains a lease as service arrangements are a frequent grey area. It is worth getting this right early to avoid accounting or audit problems later. If you have any doubt, we would recommend seeking advice.
4. Capture the right inputs in your register
Once identified, pull every lease into a central register. This becomes the foundation for your calculations, your audit evidence, and your ongoing controls – so it is worth capturing more than just the headline figures. The sections below cover the inputs that most often cause finance teams difficulty.
Lease term
The length of the lease term has a large impact on the size of the lease liability and right-of-use asset. Working out the term for accounting purposes is rarely as simple as reading the end date off the contract. Watch for:
- Break clauses – and an honest assessment of whether they are likely to be exercised
- Options to extend the term
- Rolling or evergreen arrangements with no fixed end date
- Informal extensions that are being honoured without a formal agreement
- No formal contract at all – we see this particularly where an asset is leased from another group entity
- Uncertainty over how enforceable the lease actually is
Capture not just the dates, but the judgement you have made about the term and why as your auditor will want to see the reasoning.
Lease payments – fixed and variable
Record the full payment profile for each lease, not just the current rent. The features to flag are:
- Fixed increases built into the agreement (e.g. stepped rent rises)
- Variable payments linked to business performance or use of the asset
- Payments linked to inflation or an index such as CPI or RPI
- Peppercorn or nominal rents
Revised FRS 102 has specific rules for how each of these feeds into the liability and right-of-use asset calculation, so capturing them accurately now saves rework later.
Other clauses worth recording
A few further items commonly sit inside lease agreements and need to be captured for the calculations:
- Landlord incentives, such as fit-out contributions or rent-free periods
- Expected dilapidation and restoration costs on exit
- Potential impairment triggers – business will need to perform an impairment review at each reporting date, so note anything like vacancy, reduced usage, physical damage, subletting or adverse business changes.
A complete register should capture lease term and break dates, the full rental payment profile, key contractual terms, start and end dates, and any unusual or complex clauses.
Determine your borrowing rate
Your borrowing rate is a key part of the calculation, and it is one of the more judgemental inputs. Businesses with multiple leases, high rental payments or longer terms may find their numbers are materially sensitive to the rate selected.
Revised FRS 102 offers several options for arriving at a rate, so judgement is required – particularly where it is unclear whether a rate is stated in the lease, where there is no obvious borrowing benchmark, or where multiple lease types exist across the business. Our technical guide explains how each option works; the practical point is to choose deliberately and document why.
Those whose calculations are sensitive to the rate may need help arriving at one appropriate to their business. We work alongside a number of partners and can put you directly in contact with them to settle on a rate specific to your circumstances, taking the pain out of this step.
Calculate your lease liability and right-of-use asset
Once you are confident you have captured every lease and determined the key inputs, you can move to the calculation itself. The mechanics – initial recognition, how the liability unwinds, and how the right-of-use asset depreciates – are set out in full in our comprehensive technical guide, which is the right companion piece for this stage.
For more information, view we explain the recent changes in our guide to FRS 102 leases.
Lease accounting example
To show how the inputs come together in practice, take a straightforward four-year office lease with rent of £20,000 a year, paid annually, and a borrowing rate of 5%.
- Lease liability at initial recognition is the four years of payments discounted back at 5% – giving an opening liability of roughly £70,900 rather than the £80,000 headline total, because future payments are worth less in today’s terms.
- Right-of-use asset starts at the same figure, then has any items such as a landlord incentive deducted or initial direct costs and expected dilapidations added. If the landlord gave a £4,000 fit-out contribution, the opening asset would be around £66,900.
- Subsequently, the asset is depreciated on a straight-line basis over the four years, while the liability reduces by each payment made and accretes by the annual interest charge as the discount unwinds.
A real lease with break clauses, index-linked rent or a less certain term will be more involved, but it shows why capturing the term, the payment profile and any incentives accurately in your register is what drives the numbers.
Why you should engage your auditor early
The judgements you have made, on lease term, borrowing rate, dilapidations and impairment, will all need to be clearly articulated and supported for your auditor. We recommend engaging with them early and working through these areas before year-end fieldwork. Doing so takes the work off the critical path and reduces the risk of delays once the audit begins.
Next steps for finance teams
For many finance teams, capitalising leases is either brand new or something they have not dealt with in years. The work of identifying every lease, capturing the judgemental inputs and building defensible calculations should not be underestimated – but it is very manageable with a clear plan and an early start.
If you would like a second pair of hands on your lease register, your borrowing rate, or the conversations with your auditor, Mercer and Hole’s Financial Reporting Advisory team would be glad to help. Where the borrowing rate is finely balanced, we can also put you directly in touch with the specialists we work alongside to settle on a defensible figure. Get in touch and we will help you turn the requirements into a straightforward, well-evidenced process.
Related articles in our FRS 102 changes series:
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