FRS 102 Modified Retrospective Example

What modified retrospective means

Under the modified retrospective approach, a business recognises the cumulative effect of moving to the new FRS 102 lease accounting rules as a one-time adjustment at the start of the first period in which the new rules apply: the transition date.

Importantly, prior period comparatives are not restated. The financial statements for the period immediately before transition are presented under the old rules, and the new rules apply only from the transition date onwards.

FRS 102 requires this modified approach rather than a full retrospective transition, which would rebuild amortisation schedules back to the original commencement date of each lease. Full retrospective restatement was an option under IFRS 16, but it is not permitted under FRS 102.

For a short definition of the term, see the modified retrospective approach glossary entry.

Why FRS 102 uses modified retrospective

The amended standard requires the modified approach, which keeps the transition manageable because:

• It avoids the need to reconstruct historical calculations going back to when leases were originally entered into
• It does not require restating previously filed comparative figures
• It still produces a complete and accurate set of lease accounting figures from the transition date onwards
• The transition workload is far lower than a full retrospective restatement would be

What data is needed at the transition date

To apply the modified retrospective approach, the following information is required for each lease at the transition date:

• The remaining lease payments from the transition date to the end of the lease term
• The lease term, including any optional extension periods that are reasonably certain to be exercised
• The incremental or obtainable borrowing rate at the transition date
• Any prepaid lease payments, initial direct costs, lease incentives, or restoration obligations

The transition date, known as the date of initial application, is the first day of the period in which the entity first applies the new requirements. For a December year end first applying the rules in 2026, that is 1 January 2026.

How the opening lease liability is calculated

The opening lease liability is the present value of the remaining lease payments at the transition date, discounted at the incremental or obtainable borrowing rate at that date.

This is effectively the same calculation that would apply to a new lease on the transition date. The difference is that the remaining payments and term reflect where the lease stands at transition, not at its original commencement.

How the right-of-use asset is recognised

Under the modified retrospective approach, the right-of-use asset is generally set equal to the lease liability at the transition date. This is the simplest application of the method.

Adjustments are then made for:

• Prepaid lease payments: added to the right-of-use asset
• Accrued lease payments: deducted from the right-of-use asset
• Initial direct costs: added to the right-of-use asset
• Lease incentives received: deducted from the right-of-use asset
• Restoration provisions: if a provision has been recognised, the corresponding asset component is included

Worked example: office lease

Suppose a business has a five-year office lease that commenced on 1 January 2024. The business has a December year end and is transitioning to the new FRS 102 rules on 1 January 2026.

At the transition date:

• Remaining lease term: 3 years (1 January 2026 to 31 December 2028)
• Annual lease payment: £24,000 payable in arrears
• Incremental borrowing rate at 1 January 2026: 5.5%
• No prepaid payments, incentives or restoration obligations

The payments fall due on 31 December 2026, 31 December 2027 and 31 December 2028. The present value of those three annual payments of £24,000 at 5.5% is £64,762 to the nearest pound.

Each payment is discounted from its actual date at the annual effective rate over exact days (days divided by 365.25), the same convention as the AuditLease calculator and product. A hand calculation on whole periods will differ by a small amount. Figures on this page are rounded to the nearest pound; the calculator shows pence.

From 1 January 2026, the business will also recognise:

• Interest on the lease liability using the effective interest method
• Depreciation of the right-of-use asset on a straight-line basis over the remaining lease term
• Reduction of the lease liability by the cash payments made

Common audit evidence required at transition

Auditors will want to see the following at the transition date:

• Source lease agreements for each lease subject to the new rules
• Written documentation of the lease term judgement: which periods are included and why
• Support for the incremental or obtainable borrowing rate used, including evidence of how the rate was determined
• Present value calculation workings, showing the remaining payments and discount rate applied
• The opening journal and its supporting calculation
• Exemption assessments for any leases treated as short-term or low-value

Judgement areas and limitations

The modified retrospective approach involves several significant judgements:

• Lease term. Which optional extension periods are included? The judgement must reflect facts and circumstances at the transition date, not at the original commencement date.
• Incremental or obtainable borrowing rate. The rate is determined for each lease at the transition date. An incremental borrowing rate reflects a similar term, similar security and a similar economic environment, for the funds necessary to obtain an asset of similar value to the right-of-use asset. An obtainable borrowing rate reflects a similar term and an amount similar to the total undiscounted value of the lease payments to be included in the measurement of the lease liability. The lessee chooses between them lease by lease, so using a single rate for all leases may not be appropriate.
• Practical expedients. FRS 102 offers transition expedients, including a single discount rate for a portfolio of leases with reasonably similar characteristics and the use of hindsight (paragraph 1.53), not reassessing whether a contract is or contains a lease (paragraph 1.45), and using IFRS 16 carrying amounts calculated for group consolidation (paragraph 1.48). Paragraphs 1.45 and 1.48 require the fact of use to be disclosed, and a description of the transitional provisions applied is always required (paragraph 1.50).

All judgements should be documented at the time of transition, not retrospectively. Auditors will ask how and when the judgements were made.

Frequently asked questions

This guide is for general information only and does not constitute accounting advice. Finance teams should consult a qualified accountant for advice specific to their circumstances.