A lessor under FRS 102 still classifies every lease as either a finance lease or an operating lease, depending on whether it transfers substantially all the risks and rewards of ownership to the lessee. Under a finance lease the lessor removes the asset and shows a receivable equal to its net investment in the lease, earning finance income at a constant rate. Under an operating lease it keeps and depreciates the asset and recognises rent as income, normally on a straight line basis.
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Did the 2026 changes to FRS 102 alter lessor accounting?
Not in substance. The Periodic Review 2024 amendments, mandatory for accounting periods beginning on or after 1 January 2026, moved most lessees onto a single on balance sheet model, but ACCA’s technical factsheet on the changes states that there have been no changes to the way lessors initially recognise and measure leases. The revised Section 20 does reorganise the lessor requirements into paragraphs 20.86 to 20.121, adds rules on lease modifications and subleases, and expands lessor disclosures. The lessee side is covered in FRS 102 changes from January 2026.
How does a lessor decide between a finance lease and an operating lease?
Paragraph 20.86 requires each lease to be classified, and paragraph 20.87 sets the test: a finance lease transfers substantially all the risks and rewards incidental to ownership of the underlying asset; an operating lease does not. Paragraph 20.88 says substance prevails over the form of the contract and lists situations that would normally lead to finance lease classification:
- ownership passes to the lessee by the end of the lease term;
- the lessee has a purchase option at a price expected to be so far below fair value that exercise is reasonably certain at inception;
- the lease term is for the major part of the asset’s economic life, even if title does not pass;
- at inception, the present value of the lease payments amounts to at least substantially all of the asset’s fair value; or
- the asset is so specialised that only the lessee can use it without major modification.
Paragraph 20.89 adds indicators that could also point to a finance lease: the lessee bears the lessor’s losses if it cancels; gains or losses on the residual value fall to the lessee; or the lessee can continue for a secondary period at a rent substantially below market. FRS 102 sets no percentage thresholds, so “major part” and “substantially all” are judgements.
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Are the indicators always decisive?
No. Paragraph 20.90 says the examples and indicators are not always conclusive. If other features make it clear that substantially all the risks and rewards have not passed, the lease is an operating lease. The standard gives two examples: ownership transfers at the end for a variable payment equal to fair value at that time, or there are variable lease payments as a result of which the lessor keeps significant risk. Under paragraph 20.91, classification is made at the inception date and is revisited only if there is a lease modification. Changes in estimates of economic life or residual value, or a lessee default, do not trigger reclassification.
How does a lessor account for a finance lease?
At commencement the lessor recognises a receivable equal to its net investment in the lease (paragraph 20.93). The glossary defines this as the gross investment, meaning the lease payments receivable plus any unguaranteed residual value, discounted at the interest rate implicit in the lease (paragraph 20.94). Initial direct costs are automatically included through that rate (paragraph 20.95). The lease payments counted are set out in paragraph 20.96: fixed payments less incentives, index or rate linked payments, residual value guarantees, purchase options reasonably certain to be exercised and termination penalties reflected in the lease term.
Afterwards, paragraph 20.101 requires finance income to be recognised on a pattern giving a constant periodic rate of return on the net investment, with each receipt reducing both principal and unearned income (paragraph 20.102). Paragraph 20.103 applies the impairment and derecognition rules in Sections 11 or 12 to the receivable and requires regular review of unguaranteed residual values, with any fall recognised immediately.
Manufacturer or dealer lessors
A manufacturer or dealer that offers a finance lease as an alternative to selling recognises revenue at the lower of the asset’s fair value and the present value of the lease payments at a market rate, cost of sale at carrying amount less the present value of any unguaranteed residual, and the selling profit at commencement (paragraph 20.97). If an artificially low interest rate is quoted, selling profit is restricted to what a market rate would give (paragraph 20.99). Costs of obtaining the lease are expensed, not included in the net investment (paragraph 20.100).
How does a lessor account for an operating lease?
The asset stays on the lessor’s balance sheet, presented according to its nature (paragraph 20.113), and is depreciated under its normal policy for similar assets (paragraph 20.109) and tested for impairment under Section 27 (paragraph 20.110). Leased property that meets the definition of investment property follows Section 16 instead; see investment property accounting.
Lease income is recognised on a straight line basis under paragraph 20.106 unless another systematic basis better reflects how the benefit from the asset diminishes, or the payments are structured to rise with expected general inflation, based on published indices, to compensate the lessor for expected inflationary cost increases. Paragraph 20.106(b) adds that if payments vary according to factors other than general inflation, the exception does not apply. Initial direct costs are added to the asset and expensed over the lease term on the same basis as the income (paragraph 20.108). A manufacturer or dealer recognises no selling profit on an operating lease (paragraph 20.111), and a modification is treated as a new lease from its effective date (paragraph 20.112).
What do the two models look like in numbers?
Illustration only. Finance lease. A lessor leases equipment with a fair value of £27,232 for three years at £10,000 a year in arrears, with no residual value. The rate implicit in the lease is 5%.
| Year | Opening receivable | Finance income at 5% | Payment received | Closing receivable |
|---|---|---|---|---|
| 1 | £27,232 | £1,362 | £10,000 | £18,594 |
| 2 | £18,594 | £930 | £10,000 | £9,524 |
| 3 | £9,524 | £476 | £10,000 | £0 |
Illustration only. Operating lease. A landlord lets offices for five years with six months rent free and £24,000 a year after that. Total rent is £108,000. Paragraph 20.37 includes rent free periods in the lease term, so income is £21,600 a year on a straight line basis, with an accrued income debtor building up in the early years.
How are subleases classified?
A business that leases an asset and sublets it is an intermediate lessor. Paragraph 20.92 classifies the sublease by reference to the right of use asset from the head lease, not the underlying asset, unless the head lease is a short term lease taken off balance sheet, in which case the sublease is an operating lease. So subletting a whole floor for the remainder of a five year head lease is likely to be a finance lease of the right of use asset, even though it would be nowhere near the economic life of the building. Paragraph 20.94 lets the intermediate lessor use the head lease discount rate if the sublease rate cannot be readily determined. A head lease of an asset that is, or will be, sublet cannot use the low value exemption (paragraph 20.12); see short term and low value lease exemptions.
What must a lessor disclose?
Paragraphs 20.114 and 20.115 require a general description of significant leasing arrangements, with further qualitative and quantitative information where needed. Paragraph 20.116 requires the period’s selling profit, finance income and income from unrecognised variable payments for finance leases, and lease income for operating leases, with variable income not linked to an index or rate shown separately. For finance leases, paragraph 20.118 requires a maturity analysis of undiscounted payments receivable for each of the first five years and a total thereafter, reconciled to the net investment. For operating leases, paragraph 20.121 requires the same five year maturity analysis, and paragraph 20.119 requires property, plant and equipment disclosures to separate leased out assets from assets the lessor uses itself; see property, plant and equipment under FRS 102.
Common mistakes include recognising stepped or rent free leases on a cash basis, reclassifying when a lessee defaults, and classifying subleases by the life of the building.
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Related Accountapedia entries
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- Sale and leaseback accounting
- Bringing existing leases onto the balance sheet in 2026
Sources
- ACCA: Tf lease accounting under frs102 1024
- Financial Reporting Council: Frs 102
- Financial Reporting Council: FRS 102 September 2024 tmKYWO6
Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.