What Lease Liability Means Under Revised FRS 102
The lease liability under revised FRS 102 Section 20 is the present value of all future lease payments that a lessee is obligated to make over the lease term. Effective for accounting periods beginning on or after 1 January 2026, the new Section 20 eliminates the operating/finance lease distinction and requires every qualifying lease to appear on the balance sheet as a right-of-use (ROU) asset and a corresponding lease liability.
This is a fundamental change for UK and Irish entities. Previously, operating leases were expensed on a straight-line basis with no balance sheet recognition. Now, if you have committed to paying £10,000 per month for five years, the lease liability is not £600,000 (the sum of all payments). It is the present value of those payments — approximately £530,660 at a 5% discount rate — because money paid in the future is worth less than money paid today.
This guide walks through the complete calculation, from the PV formula to journal entries and ongoing remeasurement. For an overview of all FRS 102 changes taking effect in 2026, see our companion article. For the IFRS 16 equivalent calculation, see our step-by-step lease liability guide.
What Is a Lease Liability Under FRS 102
A lease liability represents the lessee's financial obligation to make payments for the right to use an underlying asset. Under the revised Section 20, the measurement of this liability must include certain payments and exclude others.
Payments Included in the Lease Liability
Fixed payments. The contractual periodic amounts the lessee must pay, less any lease incentives receivable from the lessor (such as rent-free periods or fit-out contributions).
Variable payments linked to an index or rate. Payments that depend on an index (such as RPI or CPI) or a rate (such as a benchmark interest rate), measured using the index or rate value at the commencement date. These are included because they represent unavoidable obligations — the lessee will pay whatever the index dictates.
Purchase option exercise prices. If the lessee is reasonably certain to exercise a purchase option, the option price is included in the lease liability at commencement.
Guaranteed residual values. Amounts the lessee expects to pay under residual value guarantees — the amount the lessee guarantees to the lessor that the asset will be worth at the end of the lease term.
Payments Excluded from the Lease Liability
Variable payments based on performance or usage. Payments tied to revenue generated, units produced, or hours of use are not included. These are expensed as incurred because they are not fixed obligations.
Service components. If the lease contract bundles non-lease services (maintenance, cleaning, security), these must be separated and expensed outside the lease liability — unless the entity elects not to separate lease and non-lease components, in which case the entire payment is included.
Step-by-Step Calculation
The lease liability is calculated using the present value of an annuity formula. For level (equal) payments, the formula is:
Lease Liability = PMT × [(1 - (1 + r)^(-n)) / r]
Where:
- PMT = the periodic lease payment
- r = the discount rate per period (annual rate ÷ number of periods per year)
- n = the total number of payment periods
Worked Example
Lease terms:
- Asset: office space in Manchester
- Monthly rent: £10,000 (paid at the end of each month)
- Lease term: 5 years (60 months)
- Obtainable borrowing rate: 5% per annum
- Commencement date: 1 January 2026
- No lease incentives, prepayments, or restoration obligations
Step 1: Convert the Annual Rate to a Monthly Rate
Monthly rate (r) = 5% / 12 = 0.4167% = 0.004167
Step 2: Determine the Number of Periods
n = 5 years × 12 months = 60 periods
Step 3: Calculate the Present Value
Lease Liability = PMT × [(1 - (1 + r)^(-n)) / r]
= £10,000 × [(1 - (1.004167)^(-60)) / 0.004167]
= £10,000 × [(1 - 0.77920) / 0.004167]
= £10,000 × [0.22080 / 0.004167]
= £10,000 × 53.066
= £530,660
The lessee recognises a liability of £530,660 on 1 January 2026 — not the £600,000 total of undiscounted payments. The difference of £69,340 represents the total interest expense that will be recognised over the 5-year lease term.
First Three Rows of the Amortisation Schedule
| Month | Opening Balance (£) | Interest Expense (£) | Payment (£) | Principal (£) | Closing Balance (£) |
|---|---|---|---|---|---|
| 1 | 530,660 | 2,211 | 10,000 | 7,789 | 522,871 |
| 2 | 522,871 | 2,179 | 10,000 | 7,821 | 515,050 |
| 3 | 515,050 | 2,146 | 10,000 | 7,854 | 507,196 |
In Month 1, £2,211 of the £10,000 payment is interest expense and £7,789 reduces the principal. Each subsequent month, the interest portion decreases and the principal portion increases as the outstanding balance declines.
Amortisation Schedule Explained
After initial recognition, the lease liability is measured using the effective interest method. Each periodic payment is split into two components:
- Interest expense = opening liability balance × monthly rate (0.4167%)
- Principal reduction = payment − interest expense
The interest portion is highest in Month 1 and declines every month as the outstanding balance reduces. Conversely, the principal portion starts small and grows. This is the same mechanics as a repayment mortgage.
Here is the amortisation schedule for selected periods across the full 5-year term:
| Month | Opening Balance (£) | Interest Expense (£) | Payment (£) | Principal (£) | Closing Balance (£) |
|---|---|---|---|---|---|
| 1 | 530,660 | 2,211 | 10,000 | 7,789 | 522,871 |
| 2 | 522,871 | 2,179 | 10,000 | 7,821 | 515,050 |
| 3 | 515,050 | 2,146 | 10,000 | 7,854 | 507,196 |
| 6 | 491,447 | 2,048 | 10,000 | 7,952 | 483,495 |
| 12 | 436,049 | 1,817 | 10,000 | 8,183 | 427,866 |
| 24 | 318,897 | 1,329 | 10,000 | 8,671 | 310,226 |
| 36 | 195,253 | 814 | 10,000 | 9,186 | 186,067 |
| 48 | 64,820 | 270 | 10,000 | 9,730 | 55,090 |
| 59 | 19,835 | 83 | 10,000 | 9,917 | 9,918 |
| 60 | 9,918 | 41 | 10,000 | 9,918 | 0 |
| Total | 69,340 | 600,000 | 530,660 |
The Front-Loaded Interest Pattern
This pattern has a direct impact on the income statement. In Month 1, the interest expense is £2,211. By Month 60, it is just £41. Combined with straight-line ROU asset depreciation, the total lease expense is higher in early periods and lower in later periods. This front-loading is a significant change from the previous straight-line operating lease expense treatment under old FRS 102.
The total interest of £69,340 over the lease term equals the difference between total undiscounted payments (£600,000) and the initial liability (£530,660). This serves as a useful check on the calculation.
Initial Recognition Journal Entry
At the commencement date, the lessee records the following entry:
Dr Right-of-Use Asset 530,660
Cr Lease Liability 530,660
Adjustments to the ROU Asset
If there are additional items at commencement, the ROU asset is adjusted:
Initial direct costs (e.g., £3,000 in legal fees for negotiating the lease):
Dr Right-of-Use Asset 3,000
Cr Cash 3,000
Lease incentives received (e.g., £20,000 fit-out contribution from the landlord):
Dr Cash 20,000
Cr Right-of-Use Asset 20,000
Prepayments made (e.g., £10,000 first month's rent paid before commencement):
Dr Right-of-Use Asset 10,000
Cr Prepayments 10,000
After these adjustments, the ROU asset would be: £530,660 + £3,000 − £20,000 + £10,000 = £523,660.
The lease liability remains at £530,660 — adjustments affect only the ROU asset.
Subsequent Measurement
After initial recognition, both the lease liability and the ROU asset require ongoing measurement each reporting period.
Lease Liability: Interest Unwinding
Each month, the payment is recorded using the effective interest method:
Dr Interest Expense 2,211
Dr Lease Liability 7,789
Cr Cash 10,000
The interest expense (£2,211 in Month 1) is calculated as the opening balance (£530,660) multiplied by the monthly rate (0.4167%). The remainder of the payment (£7,789) reduces the lease liability.
ROU Asset: Depreciation
The ROU asset is depreciated on a straight-line basis over the shorter of the lease term and the useful life of the underlying asset. If the lease term is 5 years:
Monthly depreciation = £523,660 / 60 = £8,728
Dr Depreciation Expense 8,728
Cr Accumulated Depreciation 8,728
Combined Income Statement Impact
In Month 1, the total lease-related expense is: £2,211 (interest) + £8,728 (depreciation) = £10,939. Under the old operating lease treatment, the expense would have been a flat £10,000. This front-loaded pattern reverses over the lease term — in later months, the interest component drops and total expense falls below £10,000.
When to Remeasure
The lease liability must be remeasured — not just continued with the original schedule — when certain events occur. The remeasurement adjusts both the liability and the ROU asset.
Remeasurement Triggers
FRS 102 identifies four categories of events that trigger remeasurement of the lease liability:
1. Change in Lease Term Assessment
If the lessee's assessment of whether it will exercise an extension option or a termination option changes — for example, a tenant originally expected to break at Year 3 but now intends to stay for the full 5-year term — the remaining payments must be recalculated and rediscounted. This requires a revised discount rate at the remeasurement date.
2. Change in Purchase Option Assessment
If the lessee's expectation of exercising a purchase option changes (from not reasonably certain to reasonably certain, or vice versa), the option price is added to or removed from the future payments. This also requires a revised discount rate.
3. Change in Residual Value Guarantee Amounts
If the amounts expected to be payable under a residual value guarantee change, the liability is adjusted. This uses the original discount rate.
4. Change in Future Payments from Index or Rate Changes
When index-linked or rate-linked payments change — for example, an annual RPI adjustment increases the monthly rent from £10,000 to £10,300 — all remaining payments are recalculated at the new amount and rediscounted. This uses the original discount rate.
Example: RPI-linked adjustment. After 12 months, the lease payment increases from £10,000 to £10,300 due to a 3% RPI increase. The remaining 48 payments of £10,300 are discounted at the original 5% annual rate:
Revised Liability = £10,300 × [(1 - (1.004167)^(-48)) / 0.004167]
= £10,300 × 43.422
= £447,247
Previous Liability (Month 12 closing) = £427,866
Adjustment = £447,247 - £427,866 = £19,381
Journal entry:
Dr Right-of-Use Asset 19,381
Cr Lease Liability 19,381
The adjustment goes to the ROU asset, not through profit or loss.
Practical Tips
Use the Calculator
Rather than building a spreadsheet from scratch, use our free FRS 102 lease liability calculator to compute the present value, generate the amortisation schedule, and model different discount rate scenarios. It handles monthly, quarterly, and annual payment frequencies and produces results in GBP.
Determining the OBR
The obtainable borrowing rate (OBR) is the rate at which the entity could borrow an amount similar to the total undiscounted lease payments, over a similar term, with similar security. Practical approaches include:
- Entities with existing bank debt: Use the rate on existing facilities as a starting point, adjusted for the lease term
- Entities without borrowings: Obtain indicative quotes from banks or use published benchmark rates plus an appropriate credit spread
- Portfolio approach: Group leases with similar characteristics (term, currency, asset type) and apply a single rate
The OBR is generally simpler to determine than the IFRS 16 incremental borrowing rate, which requires entity-specific adjustments for each individual lease.
Handling Rent-Free Periods
If a lease includes an initial rent-free period (e.g., 3 months free on a 5-year lease), the total payments are spread over the full lease term for measurement purposes. The lease liability is calculated on the payments actually due — but the ROU asset still reflects the full right-of-use period. In practice, the rent-free period reduces the total consideration, lowering both the initial liability and the ROU asset compared to a lease without the rent-free period.
Short-Term and Low-Value Exemptions
Two exemptions allow entities to avoid the full on-balance-sheet treatment:
Short-term leases. Leases with a remaining term of 12 months or less at commencement (with no purchase option) can be expensed on a straight-line basis. The exemption is applied lease by lease.
Low-value assets. Unlike IFRS 16, FRS 102 does not specify a monetary threshold. Entities apply judgement to determine what constitutes low value — typically small items like laptops, tablets, or office furniture. The assessment is based on the value of the asset when new, regardless of materiality to the reporting entity.
Even where exemptions are applied, entities must disclose a maturity analysis of undiscounted payments for exempt leases.
Link to Other FRS 102 Resources
For a complete overview of all changes taking effect in 2026, including transition requirements, covenant implications, and tax considerations, see our guide to FRS 102 lease accounting changes 2026. For the IFRS 16 equivalent of this calculation, see how to calculate lease liability under IFRS 16.
Conclusion
Calculating lease liability under revised FRS 102 Section 20 is mechanically straightforward — it is a present value calculation — but the judgment involved in determining the OBR and assessing lease term options, combined with the ongoing obligation to remeasure, makes it a sustained compliance effort.
The core formula: Lease Liability = Payment × [(1 − (1 + r)^(−n)) / r]. For the worked example — £10,000/month, 5 years, 5% OBR — that produces an initial liability of £530,660, total interest of £69,340, and a front-loaded expense pattern that differs materially from the straight-line treatment under the old standard.
Get the inputs right, build the amortisation schedule, record the entries, and monitor for remeasurement triggers. The difficulty lies not in the maths but in the data — which is why accurate lease data extraction is the foundation of reliable FRS 102 compliance.
Need to calculate lease liability across your property portfolio? Try our free FRS 102 lease liability calculator — or upload your lease documents and get automated FRS 102 calculations in minutes with LeaseIQ.