FRS 102 Modified Retrospective Transition 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.

This is simpler than full retrospective transition, which would require rebuilding amortisation schedules going back to the original commencement date of each lease.

Why many businesses will choose modified retrospective

For most UK businesses, modified retrospective is the practical choice 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 significantly lower than full retrospective

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 borrowing rate at the transition date
• Any prepaid lease payments, initial direct costs, lease incentives, or restoration obligations

The transition date is the start of the earliest comparative period presented, or the first day of the period in which the entity first applies the new requirements.

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 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 2023. 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 present value of three annual payments of £24,000 at 5.5% is approximately £64,900.

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 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 borrowing rate. The rate should reflect the lessee's credit quality, the lease term, and the nature of the asset at the transition date. Using a single rate for all leases is a simplification that may not be appropriate for all businesses.
• Practical expedients. FRS 102 allows certain practical expedients on transition, such as using a single discount rate for a portfolio of leases with similar characteristics. These must be disclosed.

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.