Until recently a UK company using FRS 102 split its leases into finance leases (on the balance sheet) and operating leases (an expense as the rentals were paid). The FRC’s periodic review changed that for lessees: for accounting periods beginning on or after 1 January 2026, most leases go on the balance sheet, in a model close to IFRS 16. The chart of accounts needs a few new lines to cope.
Who is affected
| Framework | Lessee treatment |
|---|---|
| FRS 102 (including section 1A small companies) | right-of-use asset and lease liability for most leases |
| FRS 105 (micro-entities) | unchanged: rentals on operating leases are expensed; finance leases capitalised |
| Short-term leases (12 months or less) and leases of low-value assets | may stay off balance sheet as an expense, if the exemption is chosen |
Typical leases caught: property leases, vehicle contract hire, long-term equipment rentals. Hire purchase, where ownership passes to the business, was already on the balance sheet and is accounted for as an asset purchase with a loan.
Accounts to add
| Account | Type |
|---|---|
| Right-of-use assets – property | fixed asset |
| Right-of-use assets – vehicles and equipment | fixed asset |
| Accumulated depreciation – right-of-use assets | contra-asset |
| Lease liabilities – due within one year | current liability |
| Lease liabilities – due after one year | non-current liability |
| Interest on lease liabilities | finance cost |
| Depreciation of right-of-use assets | expense |
| Short-term and low-value lease costs | expense for exempt leases |
Worked example
A company leases a van for four years at £6,000 a year, paid in arrears. Discounting the payments at 5% (the rate implicit in the lease, or the company’s incremental borrowing rate if that is not known) gives a present value of £21,276.
At the start:
| Account | Debit | Credit |
|---|---|---|
| Right-of-use assets – vehicles | £21,276 | |
| Lease liabilities | £21,276 |
In the first year the asset is depreciated (£5,319 straight line), 5% interest is added to the liability, and the £6,000 payment reduces it:
| Account | Debit | Credit |
|---|---|---|
| Depreciation of right-of-use assets | £5,319 | |
| Accumulated depreciation – right-of-use | £5,319 | |
| Interest on lease liabilities | £1,064 | |
| Lease liabilities | £4,936 | |
| Bank | £6,000 |
Total cost over the lease still equals the payments, but it is front-loaded because interest is highest early on. Profit before interest improves compared with the old rental expense, and the balance sheet shows more assets and debt, which can affect loan covenants and the company’s size thresholds.
VAT and tax are unchanged
Each rental invoice still carries the same VAT, reclaimed when invoiced. For corporation tax, leases accounted for this way generally follow the accounting entries, but there are specific rules for long funding leases and on transition. Ask your accountant how the transition adjustment is treated before the first year’s accounts are drafted.
Transition checklist
- List every lease with its term, payments, break clauses and renewal options.
- Decide which exemptions to apply and document the low-value policy.
- Calculate opening right-of-use assets and liabilities at the date of initial application, using the transition reliefs available.
- Update loan covenant calculations and budgets.
Lease incentives such as rent-free periods now reduce the right-of-use asset rather than being spread through accruals. For the older model and finance lease basics, see lease accounting, and for property running costs, rent and premises costs.