Disclosing Operating Leases with Break Clauses (FRS102)

Disclosing operating leases under FRS102 is generally a simple process:

• You calculate the value of remaining lease payments to be made.Then a disclosure is made for the amount of payments to be made within the next year, between 2 and 5 years and 5 years plus, based on the date of the balance sheet

This tends to be a simple process, provided there is a clear lease agreement in place that states the annual payments to be made and there is a clear start and end date for the lease. However, this can become more difficult when there are other items to take in to account; for example, a break clause.

What is a Break Clause?

A break clause is effectively a point in the lease where, if the lessee (the party leasing the asset) wanted, they could choose to end the lease there and then. This happens regularly in practice where a business may choose to lease a building for 7 years but the lease allows a break clause at the 5 years point where the lessee could give reasonable notice and then vacate the property and have no further obligations to make repayments on the lease.

How does this affect the disclosure?

Under FRS102, the disclosure requirements state that the disclosure must only be made up until the point that the lessee can contractually avoid making payments on the lease. This describes a break clause since the lessee could, if they chose to, stop making payments on the lease on the date of the break clause.

Example

Jones Ltd has a year end of 31/12/2019. They have an operating lease agreement in place with annual repayments of £20,000 that started on the 01/01/2019 and is due to end on the 31/12/2023 (5 years). There is a break clause date of 31/12/2021 where provided Jones Ltd has given 3 months notice, they could end the lease on that date.

1. Determine the length of the lease: The lease runs for 5 years (start of 2019-end of 2023)
2. Determine length of lease with break clause: Since the break clause date is 31/12/2021, the requirement for disclosure is only 2 years (from balance sheet date of 31/12/2019)
3. Calculate disclosure: The amount due in less than 1 year will be £20,000 (1 year to 31/12/2020) and the amount due in 2 to 5 years will also be £20,000 (1 more year to break clause date of 31/12/2021)
4. Disclose: Obligations under operating leases

Due in less than 1 year 20

Due in 2 to 5 years 20

Greater than 5 years 0

The latest version of FRS102 can be found here, for your reference:

Please note that for all businesses reporting under IFRS with periods beginning on or after 01/01/2019, the new leasing standard, IFRS16, must be used to disclose all leases on the balance sheet. This includes the disclosure of operating leases. This does no in any way affect businesses reporting under FRS102 and disclosing operating leases with break clauses under FRS102 will remain the same.

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