Introduction
Property leases are the most common and financially significant leases for UK businesses. For most entities, commercial rent represents one of the largest recurring obligations — and under the revised FRS 102 Section 20, effective from 1 January 2026, these obligations now go on the balance sheet as right-of-use (ROU) assets and lease liabilities.
This guide covers the practical scenarios that UK accountants deal with daily when accounting for commercial property leases under the new standard: rent-free periods, break clauses, dilapidations, stepped rents, service charges, subleases, and transition from existing leases. Each section includes the accounting treatment, practical considerations, and worked examples where applicable.
For a general overview of the FRS 102 changes, see our guide on FRS 102 lease accounting changes 2026. For the mechanics of calculating lease liabilities and ROU assets, see our lease liability guide and ROU asset guide.
Scope: Which Property Leases Are Affected
Under the new Section 20, virtually all commercial property leases are within scope. This includes:
- Office leases — from single-room serviced offices to multi-floor headquarters
- Retail premises — high street shops, shopping centre units, retail parks
- Warehouses and distribution centres — industrial and logistics space
- Industrial units — factories, workshops, manufacturing facilities
- Mixed-use properties — buildings combining commercial and residential elements (the commercial portion is within scope)
What is excluded:
- Short-term leases — leases with a remaining term of 12 months or less at the commencement date (or at the transition date for existing leases). These may be expensed on a straight-line basis
- Leases of intangible assets — software licences, intellectual property rights (outside Section 20's scope)
- Low-value assets — note that this exemption is effectively irrelevant for property leases, since buildings are always high-value assets regardless of the entity's size
The critical point: almost every commercial property lease in the UK will now require on-balance-sheet recognition. There is no materiality threshold — if it is a lease and it is not short-term, it goes on the balance sheet.
Rent-Free Periods
Rent-free periods are extremely common in UK commercial property leases. Landlords typically offer 3 to 12 months of rent-free occupation at the start of a lease as an incentive, particularly in competitive markets or for longer lease commitments.
Under FRS 102 Section 20, rent-free periods affect the lease calculation as follows:
The lease liability is calculated based on the full lease term, including the rent-free period. The commencement date is when the lessee obtains the right to use the property — which is typically the start of the rent-free period, not the date when cash payments begin.
During rent-free months, no cash payment reduces the liability. Interest continues to accrue on the outstanding lease liability during the rent-free period, increasing the balance. This is a significant change from the previous treatment, where the total rent was simply spread on a straight-line basis over the lease term.
ROU asset depreciation starts from commencement. The ROU asset is depreciated from the commencement date — including the rent-free period — over the lease term or the useful life of the underlying asset, whichever is shorter.
Worked Example: Rent-Free Period
Consider a typical UK commercial property lease:
- Lease term: 10 years
- Rent-free period: 6 months at commencement
- Monthly rent: £15,000 (after rent-free period)
- Discount rate (OBR): 4.5%
Step 1 — Identify the payment schedule:
- Months 1–6: £0 (rent-free)
- Months 7–120: £15,000 per month
Step 2 — Calculate the lease liability at commencement: The lease liability is the present value of all future lease payments discounted at 4.5%. Since the first 6 months have zero payments, only the 114 monthly payments of £15,000 are discounted back to the commencement date. The resulting lease liability is approximately £1,443,000.
Step 3 — Recognise the ROU asset: The ROU asset at commencement equals the lease liability (plus any initial direct costs, prepayments, or dilapidation provisions — see later sections).
Step 4 — Ongoing measurement:
- During months 1–6: interest accrues on the liability (£1,443,000 × 4.5% / 12 ≈ £5,411/month), increasing the carrying amount. No payment is made
- From month 7: monthly payments of £15,000 are split between interest and principal reduction
- ROU asset is depreciated straight-line over 120 months from day one
Use our free FRS 102 lease liability calculator to model rent-free scenarios with your own figures.
Break Clauses
Break clauses are a defining feature of UK commercial property leases. They allow one or both parties to terminate the lease before the contractual end date. Under FRS 102, break clauses are critical because they directly determine the lease term — and the lease term drives the entire calculation.
Types of Break Clause
Lessee break option: The tenant has the right (but not the obligation) to terminate the lease at a specified date. Include the period after the break in the lease term only if the lessee is not reasonably certain to exercise the break. In practice, this means assessing whether the lessee is more likely than not to continue.
Mutual break clause: Either party can terminate. The lessee's assessment focuses on their own likelihood of exercising. The landlord's ability to break is generally treated as creating uncertainty about the lease term, but the primary assessment is from the lessee's perspective.
Landlord-only break: The landlord can terminate but the tenant cannot. This is typically excluded from the lease term assessment unless there is strong evidence the landlord is likely to exercise — which is uncommon in standard commercial leases.
Practical Factors for Assessing Break Clauses
The assessment of whether a lessee is "reasonably certain" to exercise (or not exercise) a break option requires judgement. Key factors include:
- Leasehold improvements: If the lessee has invested significantly in fitting out the property, they are less likely to break
- Relocation costs: Moving costs, business disruption, staff impact, IT infrastructure — all reduce the likelihood of breaking
- Business dependency on location: Retail businesses with established footfall, or professional services firms with client-facing offices, are less likely to relocate
- Availability of alternatives: If suitable alternative properties are scarce or more expensive, the break is less likely to be exercised
- Historical pattern: If the entity has a track record of exercising breaks in similar leases, this is relevant evidence
- Remaining penalty or conditions: Some break clauses carry financial penalties or conditions (e.g., 6 months' rent as a break penalty)
Impact on Calculations
The difference can be dramatic. Consider a 10-year lease at £20,000/month with a lessee break clause at year 5, using a 5% discount rate:
- If using 5-year term: Lease liability ≈ £1,062,000
- If using 10-year term: Lease liability ≈ £1,886,000
This is a 78% difference in the recognised liability — purely based on the break clause assessment. This is why documenting the rationale is essential: auditors will scrutinise break clause assessments closely.
Dilapidations (Restoration Obligations)
Dilapidations are a distinctly UK concept (though equivalent obligations exist in other jurisdictions). They refer to the lessee's obligation to restore the property to its original condition at the end of the lease — removing alterations, repairing wear and tear, and making good any damage.
Under FRS 102, dilapidations are treated as follows:
Added to the ROU asset cost. The estimated cost of dilapidations at the end of the lease is included in the initial measurement of the ROU asset. This increases the asset value and therefore the depreciation charge over the lease term.
Separate provision created. A dilapidation provision (liability) is recognised separately from the lease liability. This is important — dilapidations are not part of the lease liability. They are a separate restoration obligation under FRS 102 Section 21 (Provisions and Contingencies).
Based on surveyor's estimate. The dilapidation amount is typically estimated by a specialist dilapidations surveyor. For initial recognition, a reasonable estimate is sufficient — it does not need to be precise, but it should be supportable.
Worked Example: Dilapidations
- Lease term: 10 years
- Monthly rent: £12,000
- Discount rate (OBR): 4.5%
- Estimated dilapidation cost: £50,000 (based on surveyor's estimate)
- Lease liability at commencement: approximately £1,144,000
ROU asset at commencement:
- Lease liability: £1,144,000
- Plus dilapidation provision: £50,000
- Total ROU asset: £1,194,000
Balance sheet at commencement:
- ROU asset: £1,194,000
- Lease liability: £1,144,000
- Dilapidation provision: £50,000
The ROU asset of £1,194,000 is depreciated over 10 years (£9,950/month). The lease liability is reduced by monthly payments less interest. The dilapidation provision is unwound (increased by a finance charge) over the lease term to reflect the time value of money, reaching the estimated £50,000 settlement amount at lease end.
Stepped Rents and Escalation
UK commercial property leases frequently include rent escalation provisions. The treatment under FRS 102 depends on the type of escalation:
Fixed Stepped Increases
Where the lease specifies known future rent increases — for example, rent of £10,000/month for years 1–3, rising to £12,000/month for years 4–6, then £14,000/month for years 7–10 — these are included in the lease liability at the known amounts.
The lease liability at commencement is the present value of all scheduled payments, including the stepped increases. This means the liability reflects the full contractual obligation from day one.
Open Market Rent Reviews
UK commercial leases often include upward-only rent review clauses, where rent is adjusted to the prevailing open market rate at specified review dates (typically every 5 years). Under FRS 102:
- Pure market reviews are variable lease payments — they are excluded from the lease liability because the future amount is not determinable at commencement
- These are expensed as incurred when the rent adjustment takes effect
- The lease liability is remeasured only when the new rent is determined at the review date
This is a significant practical simplification. It means that for a 10-year lease with a market rent review at year 5, the initial lease liability is based only on the current rent for the full 10-year term. When the review occurs and the new rent is determined, the liability is remeasured.
Index-Linked Reviews (RPI/CPI)
Where rent is linked to an index — typically RPI (Retail Prices Index) or CPI (Consumer Prices Index) — the treatment is:
- Initial measurement: Include lease payments based on the index rate at the commencement date. Do not forecast future index movements
- Remeasurement: When the index changes and the payment is adjusted, remeasure the lease liability using the revised payments and the original discount rate
- The ROU asset is adjusted correspondingly
For a detailed guide on discount rates, including how to determine the OBR for different scenarios, see our FRS 102 discount rate guide.
Service Charges and Insurance
A common question in UK commercial property leases is whether service charges and insurance premiums are included in the lease liability. The answer is clear:
Service charges are excluded. Service charges are variable payments for the upkeep of common areas, building management, and shared facilities. They are not lease payments and are expensed as incurred. Even if paid alongside rent in a single invoice, they are a separate cost.
Building insurance is excluded. Insurance premiums — whether paid directly by the lessee or recharged by the landlord — are not part of the lease payment. They are expensed separately.
Business rates are excluded. Rates payable to the local authority are a tax, not a lease payment.
Core rent is included. Only the rent payment for the right to use the property — the core lease payment — is included in the lease liability calculation.
When Bundled Services Cannot Be Separated
There is one important exception. If a lease bundles services with rent and the amounts cannot be separated — meaning the contract does not identify separate amounts for rent and services, and the entity cannot reliably estimate the split — then the entire payment may need to be treated as a lease payment.
In practice, most UK commercial leases clearly distinguish between rent and service charges. However, all-inclusive rents (common in serviced offices and some flexible workspace arrangements) may require careful analysis. Where separation is not possible, the entity should document why and treat the full amount as a lease payment.
Subleases
If a lessee subleases part or all of the property, the accounting treatment under FRS 102 requires consideration from both the head lease and sublease perspectives:
Head Lease
The lessee (now intermediate lessor) continues to recognise the ROU asset and lease liability from the head lease. The head lease accounting is unaffected by the sublease. Payments continue, interest accrues, and the ROU asset is depreciated as before.
Sublease Classification
The intermediate lessor classifies the sublease as either a finance sublease or an operating sublease. Critically, this classification is made by reference to the ROU asset from the head lease — not the underlying property.
- Finance sublease: If the sublease transfers substantially all the risks and rewards of the ROU asset to the sub-lessee (e.g., the sublease covers most of the remaining head lease term), the intermediate lessor derecognises the relevant portion of the ROU asset and recognises a net investment in the sublease
- Operating sublease: If it does not transfer substantially all risks and rewards, the intermediate lessor retains the ROU asset and recognises sublease income on a straight-line basis
Practical Considerations
- A full sublease for the remaining term of the head lease is almost certainly a finance sublease
- A sublease of part of the premises for part of the remaining term is typically an operating sublease
- The intermediate lessor must continue meeting obligations under the head lease regardless of sublease payments received
Transition for Existing Property Leases
For entities transitioning existing property leases to the new FRS 102 Section 20, the modified retrospective approach applies. This is designed to minimise complexity while bringing all leases on balance sheet.
Step-by-Step Transition
1. Lease liability at transition date: Measure at the present value of remaining lease payments from the transition date, discounted at the entity's obtainable borrowing rate (OBR) at the transition date. Include:
- Remaining fixed rent payments
- Known stepped increases
- Index-linked amounts based on the current index
- Exclude: service charges, insurance, rates, uncertain market review adjustments
2. ROU asset at transition date: Set equal to the lease liability, adjusted for:
- Any prepaid rent already on the balance sheet (added to ROU asset)
- Any accrued rent / lease incentive balances (deducted from ROU asset)
- Dilapidation provisions should be reassessed and added to the ROU asset separately
3. Retained earnings adjustment: Any difference between the ROU asset and the previous carrying amounts (prepaid rent, accrued lease incentives, straight-line accruals) is recognised as an adjustment to opening retained earnings.
4. No restatement of comparatives: The modified retrospective approach does not require restatement of comparative periods. The transition is a point-in-time adjustment at the date of initial application.
Transition Example
An entity has a 10-year property lease that commenced 3 years ago. At the transition date (1 January 2026):
- Remaining term: 7 years
- Monthly rent: £18,000
- OBR at transition: 5.0%
- Existing balance sheet items: accrued lease incentive of £30,000 (from an original 6-month rent-free period)
Lease liability: PV of 84 monthly payments of £18,000 at 5.0% = approximately £1,275,000
ROU asset: £1,275,000 − £30,000 (accrued lease incentive) = £1,245,000
Adjustment: The difference between the new ROU asset (£1,245,000) and the existing accrued lease incentive (£30,000) is recognised through opening retained earnings.
Practical Tips
Use a calculator for quick estimates. Our free FRS 102 lease liability calculator lets you model different scenarios — rent-free periods, break clause assumptions, discount rates — and see the impact on your balance sheet instantly. No signup required.
Review break clauses carefully. The break clause assessment is the single most judgemental area in property lease accounting. Document your rationale thoroughly — auditors will ask for it, and the financial impact of getting the lease term wrong is significant.
Get dilapidations surveyed. A professional survey provides defensible evidence for the dilapidation provision. Using a rough estimate is acceptable at transition, but a surveyor's report strengthens your position with auditors and provides a more accurate ROU asset value.
Document your OBR methodology. How you determined the obtainable borrowing rate should be documented clearly. Whether you used an existing facility rate, a broker quote, or a reference rate plus spread, the basis should be transparent and consistent across your lease portfolio. See our FRS 102 discount rate guide for detailed guidance.
Separate service charges from rent. Ensure your lease data clearly distinguishes between core rent and service charges. If you are working from invoices that combine both, refer back to the lease agreement for the contractual split. This directly affects the lease liability.
Plan for ongoing remeasurement. Property leases are not a one-time calculation. Rent reviews, index adjustments, break clause reassessments, and lease modifications all require remeasurement. Establish a process — whether spreadsheet-based for a small portfolio or system-based for larger portfolios — that can handle these ongoing requirements.
For more on the overall FRS 102 changes and how they affect your business, see our comprehensive guide on FRS 102 lease accounting changes 2026.