FRS 102 Lease Accounting: How Should You Really Determine the Discount Rate?

The new FRS 102 Section 20 has now come into force for accounting periods beginning on or after 1st January 2026. Many companies will be concentrating on constructing lease schedules and calculating right-of-use assets.

However, in reality, the single most important estimate – and the one most likely to be challenged by auditors – is often the most overlooked:

👉 What discount rate should you use?

The accounting standard provides a clear order of priority. However, the reality of the situation requires a more pragmatic approach.

This article will move beyond the theory and discuss how most UK companies will actually arrive at a discount rate in the real world, with the support of Financial Reporting Council (FRC) guidance.

What Discount Rate the Standard Actually Requires

FRS 102 states that a lessee should use the interest rate implicit in the lease if it can be readily determined.

If not, use either:

• the incremental borrowing rate (IBR), or

• the obtainable borrowing rate (OBR).

At transition (when existing operating leases move onto the balance sheet), the liability is discounted using IBR or OBR — not the implicit rate.

The FRC also allows companies to apply a single discount rate to a portfolio of leases with similar characteristics, which is an important practical expedient.

Why this matters: The standard is intentionally pragmatic. It recognises that calculating a theoretical financing rate is not always feasible for typical lease arrangements.

The Implicit Rate – Technically Preferable, but Practically Rare

The implicit rate is the rate at which the following two expressions are equal:

Present value of lease payments + unguaranteed residual value = Fair value of the underlying asset + lessor’s initial direct costs.

To arrive at it, a lessee would require visibility into the following:

• the fair value of the asset at inception of the lease

• the lessor’s estimate of residual value

• unguaranteed residual risk

• the lessor’s initial direct costs

The big picture here is:

👉 All of this data is the lessor’s, not the lessee’s.

Lessors do not share their views on residual value or their deal costs. Even determining the “fair value” of a leased office may not be easy.

This is exactly why the standard introduces the word “readily” in this context.

If the inputs have to be estimated, the rate is not readily determinable.

When might the implicit rate actually be known? Only in situations where the lease is economically equivalent to buying assets with finance:

Examples Include:

• vehicle finance arrangements

• leases of equipment where asset values are readily determined

• leases with bargain purchase options

• captive finance arrangements

In these cases, the agreement itself will disclose the amount financed and terms, and it will be possible to determine the rate.

However, in the case of property leases:

👉 It is safe to assume that the implicit rate is rarely readily determinable.

This is what most auditors would expect unless strong evidence exists to the contrary.

So What Will Most Companies Use? For the average SME, especially those with a single office or a small portfolio of similar properties, the practical answer is now:

👉 Incremental Borrowing Rate or Obtainable Borrowing Rate.

It is essential to understand the difference between the two.

Incremental Borrowing Rate (IBR)

The IBR is the rate at which a company would have to borrow:

• for a similar period

• with similar security

• to obtain an asset of similar value

• in a similar economic environment

Conceptually robust – but sometimes difficult to evidence.

It involves judgment on:

• What constitutes “similar security” for a lease liability?

• Is the rate based on secured or unsecured borrowing?

• How should term structure influence pricing?

For larger groups with existing debt facilities, this is usually manageable.

For smaller businesses, this can quickly become purely theoretical.

Obtainable Borrowing Rate (OBR): The Practical Discount Rate 

The OBR is the rate a company would pay to borrow an amount similar to the total undiscounted lease payments over a comparable term.

This makes OBR especially useful for SMEs because it is:

✅ Observable ✅ Documentable ✅ Auditable ✅ Easy to explain

A Real-World Example Suppose a company is implementing the new standard with:

• 6 years left on an office lease

• £900k total remaining payments

The finance team goes to their bank and gets an indicative term loan rate of:

👉 SONIA + 3.0%

That rate – properly documented – is excellent evidence of an obtainable borrowing rate.

No theoretical calculations needed.

The Portfolio Approach: Your Operational Lifeline 

One of the most useful – and often overlooked – features of FRS 102 is the practical expedient to use a single discount rate for leases with similar characteristics.

For instance:

• Several retail outlets with similar leases

• Regional offices

• Warehouses in the same economic environment

Finding a rate for each lease is rarely proportionate. Auditors will always prefer a straightforward approach over unnecessary complexity.

For most SME property holdings:

👉 One good rate is always preferable to ten poor ones.

What Auditors Actually Want to See In our experience, it rarely matters whether your rate is 5.2% or 5.6%.

Instead, auditors will ask - “Is your approach reasonable, consistent, and justified?”

A good rate memo should include:

• an explanation of why the implicit rate was not readily determinable

• which rate was chosen and why

• how the supporting evidence was gathered

• whether leases were pooled into portfolios

• when the rate was determined

A clear approach is always preferable to a complex one.

The Reality for Most Companies For a company with:

• a single office lease, or

• a small number of similar properties

…the most proportionate approach is likely to be:

✅ State that the implicit rate is not readily determinable ✅Gather borrowing evidence (usually from a lender) ✅ Use a single portfolio rate ✅ Record the approach clearly

This approach satisfies both the letter and the spirit of FRS 102.

Over-complicating the discount rate is one of the most frequent – and avoidable – transition pitfalls.

FRS 102 is not attempting to make finance teams credit pricing experts. It is asking for a reasonable estimate based on observable evidence.

If your approach is sound, logical, and consistent, you are already on a strong footing.