A lease liability under FRS 102 Section 20 is the present value of all future lease payments a lessee is obligated to make, recognised on the balance sheet on the date the lease commences. Following amendments effective for accounting periods beginning on or after 1 January 2026, most UK and Republic of Ireland organisations must now recognise this liability alongside a corresponding right-of-use asset, bringing the true scale of lease obligations onto the face of the balance sheet for the first time.
This guide covers the liability side of the balance sheet entry. For the asset side, see our companion piece FRS 102 right-of-use assets: a plain-English guide. If you are coming from an IFRS background and want to understand how FRS 102 compares with IFRS 16, see FRS 102 vs IFRS 16: key differences finance teams need to know.
Updated May 2026.
Under the old FRS 102, most leases were classified as operating leases and simply expensed as a rental charge in profit and loss. The balance sheet said nothing about them. A company with fifteen retail units, a fleet of fifty vehicles, and a data centre worth of IT equipment could present accounts that showed no lease obligations at all, because those commitments sat entirely off the balance sheet in the notes.
The Financial Reporting Council (FRC) changed this through its 2024 Periodic Review, replacing FRS 102 Section 20 with a model based on IFRS 16. The core principle is that if your organisation controls the right to use an asset for a period of time, that commitment has economic substance and belongs on your balance sheet. The lease liability is the financial measurement of that obligation: the present value, today, of every future payment you are committed to make under the lease.
The change affects all FRS 102 reporters, including private companies, charities, housing associations, and entities using Section 1A. Exemptions apply only to short-term leases (12 months or less at commencement) and leases of low-value assets. For a broader overview of what these changes mean for your organisation, see What is FRS 102? A plain-English guide for UK and Irish finance teams.
The initial lease liability is the present value of the lease payments not yet made at the commencement date, discounted to reflect the time value of money. Not all payments that relate to a lease are included. FRS 102 Section 20 specifies four categories of payments that belong in the liability calculation.
Components of the lease liability
Penalties for early termination are also included where the lease term reflects the lessee exercising a termination option. In practice, fixed monthly rent schedules and CPI-linked reviews are the two components finance teams encounter most often. The others tend to arise on specific asset types: residual value guarantees on vehicle leases, purchase options on equipment leases.
The initial lease liability feeds directly into the initial right-of-use asset. The ROU asset starts at an amount equal to the liability, adjusted for any payments made before commencement, initial direct costs, and estimated restoration provisions. Getting the liability calculation right from day one matters: every subsequent period's depreciation, interest charge, and remeasurement flows from this starting point.
FRS 102 Section 20 sets out a three-step hierarchy for choosing the discount rate: use the interest rate implicit in the lease if it can be determined; if not, use the Obtainable Borrowing Rate (OBR); and if neither is available, use the Incremental Borrowing Rate (IBR). The OBR is unique to FRS 102 and is generally simpler to document than the IFRS 16 IBR.
First choice: the interest rate implicit in the lease. This is the rate that makes the present value of the lease payments, plus any unguaranteed residual value, equal to the fair value of the underlying asset. In practice, many lessees cannot determine this rate because they do not know the lessor's internal assumptions about residual value. Where it cannot be readily determined, you move to the next option.
Second choice: the Obtainable Borrowing Rate (OBR). The OBR is defined in FRS 102 as the rate a lessee would pay to borrow, over a similar term, an amount equal to the total undiscounted value of the lease payments. Because the reference amount is the lease payments themselves, which are already known from the contract, the OBR is generally simpler to document than the IBR. A current bank facility rate, a quoted commercial mortgage rate, or a rate confirmed by your banker is a defensible starting point. You are essentially asking: what would my lender charge on a loan of this size and term?
Third choice: the Incremental Borrowing Rate (IBR). The IBR is the rate a lessee would pay to borrow funds to obtain an asset of similar value in a similar economic environment, over a similar term. IFRS 16 requires the IBR as the fallback where the implicit rate is unavailable. FRS 102 offers the OBR as a step before reaching the IBR, which makes it a practical simplification for smaller or less complex organisations. In practice, the OBR and IBR will often produce similar results; the key difference is that the OBR is more straightforward to document and defend in an audit. For a full comparison of how FRS 102 and IFRS 16 handle the discount rate, see our plain-English IFRS 16 right-of-use asset guide.
The choice of discount rate has a real impact on the numbers. A higher rate produces a lower present value, reducing the initial lease liability and right-of-use asset; a lower rate does the opposite. For organisations with large property portfolios, a one-percentage-point difference in the discount rate can move the balance sheet by millions of pounds. Documenting the rationale for your chosen rate, and applying it consistently across similar leases, is essential for audit readiness.
Once recognised, the lease liability changes in two ways each period: interest accrues on the outstanding balance (increasing the liability), and cash payments reduce it. This is the same mechanics as any amortising loan. The interest charge is calculated by applying the discount rate to the opening balance. Each cash payment reduces the liability, with the portion representing interest going to the income statement and the remainder reducing the principal.
The process of the liability gradually decreasing to zero as payments are made is sometimes called "unwinding the discount." As the liability falls, the interest charge each period also falls, because you are applying the same rate to a smaller balance. This gives a pattern familiar from any loan schedule: higher interest in early years, lower interest as the balance reduces.
Here is a simple worked example. An organisation enters into a three-year lease with annual payments of £20,000, payable at the end of each year. The lessee uses an OBR of 5%. The initial lease liability is calculated as follows: £20,000 discounted one year at 5% (£19,048) plus £20,000 discounted two years (£18,141) plus £20,000 discounted three years (£17,277), giving a total of approximately £54,465.
| Period | Opening liability | Interest at 5% | Cash payment | Closing liability |
|---|---|---|---|---|
| Commencement | £54,465 | |||
| Year 1 | £54,465 | £2,723 | £20,000 | £37,188 |
| Year 2 | £37,188 | £1,859 | £20,000 | £19,047 |
| Year 3 | £19,047 | £953 | £20,000 | £0 |
The lease liability does not stay static once set. A lease modification, such as an extension, a rent change, a change in scope, or an early termination, triggers a remeasurement of the liability. The remeasurement restates the liability at the present value of the revised remaining payments, discounted at a revised rate where the modification warrants a new rate assessment.
Modifications are one of the most time-consuming aspects of ongoing FRS 102 compliance. Every change to a lease in the portfolio requires a reassessment, a recalculation, and an update to the amortisation schedule. For organisations managing dozens or hundreds of leases, this is a continuous workload, not a one-off task. This is why purpose-built lease accounting software matters: a platform like LOIS can action remeasurements automatically when a modification is entered, rather than requiring manual recalculation from a spreadsheet.
The appearance of lease liabilities on the balance sheet changes several important financial metrics. Net debt rises. Gearing ratios change. Interest cover is affected because lease interest is now a separately reported finance cost. For organisations with bank facilities that include net debt or leverage covenants, reviewing those agreements before transition is not optional. Technical breaches caused by the accounting change, rather than by any deterioration in the business, need to be managed through proactive dialogue with lenders. For a full breakdown of how these changes flow through to your P&L, EBITDA, and financial ratios, see: How FRS 102 changes your P&L, EBITDA, and financial ratios.
For help automating lease liability calculations, amortisation schedules, and audit-ready reporting under FRS 102, LOIS provides purpose-built FRS 102 lease accounting software supported by CA-qualified accountants.
Related FRS 102 guides