Charity property leases and costs are often one of the most significant overheads for charities. However, unlike in the commercial sector, lease arrangements in charities frequently include donated or subsidised elements—such as peppercorn rents or below-market agreements. With the introduction of the updated Charities SORP (effective for accounting periods beginning on or after 1 January 2026), the accounting for these arrangements is undergoing a fundamental shift.
This article outlines the interaction between gifted lease costs and the new requirement to capitalise leases using a present value approach.
The Starting Point: Gifted or Subsidised Lease Arrangements
Charities commonly benefit from:
- Peppercorn leases – nominal rent (e.g. £1 per year)
- Below-market leases – reduced rent compared to fair value
These arrangements are not purely commercial. Instead, they often represent a non-exchange transaction, where the charity receives economic benefit without giving equivalent value in return.
Under the SORP:
- The economic benefit received (i.e. use of the property) is treated as a donated asset or service
- The value of that benefit is typically measured at fair value
- The accounting entry is broadly:
- Debit: Fixed asset (right to use property)
- Credit: Income (donation)
This reflects the underlying substance: the charity has received a resource to further its objectives, even if little or no rent is paid.
The New Framework: Capitalisation of Leases
Historically, most property leases were treated as operating leases, with rent expensed on a straight-line basis through the Statement of Financial Activities (SoFA).
From 2026, the position changes significantly:
- Most leases must be brought onto the balance sheet
- Charities will recognise:
- A right-of-use (ROU) asset
- A lease liability reflecting future payments
The lease liability is calculated as the net present value (NPV) of future lease payments, discounted using an appropriate rate (typically the incremental borrowing rate if the implicit rate is not available).
Over time:
- The ROU asset is depreciated
- The liability is reduced as payments are made and increased by interest charges
This replaces a single rent expense with a combination of depreciation and finance costs, often resulting in a front-loaded expense profile.
Interplay: What Happens When Lease Costs Are Gifted?
The interaction between gifted arrangements and the new lease model is one of the more nuanced areas for charities.
In practice, there are two components to consider:
- The Exchange Element (Lease Liability)
Where the charity makes payments (even at a reduced level), these are treated as lease payments:
- Discounted to present value → lease liability
- Matched with a corresponding ROU asset
- The Non-Exchange Element (Gifted Benefit)
Where rent is below market value:
- The difference between market rent and actual rent represents a donated benefit
- This is recognised separately as:
- Donation income
- Potentially an uplift to the value of the asset recognised
This creates a dual accounting treatment:
- Commercial component → lease accounting (NPV, liability, finance cost)
- Donated component → income recognition under SORP
This reflects the SORP’s broader framework distinguishing exchange vs non-exchange transactions.
Key Practical Implications for Charities
- Balance sheet expansion: Both assets and liabilities increase, even where cash payments are minimal
- Greater judgement required:
- Estimating discount rates
- Determining fair value of gifted elements
- More complex SoFA presentation:
- Replacement of rent expense with depreciation and interest
- Additional donation income where leases are subsidised
Trustees should also be aware that these changes may affect:
- Reserve levels
- Financial ratios and covenants
- Reported cost bases for activities
Conclusion
The 2026 SORP and FRS 102 updates introduce a more transparent and structured approach to lease accounting for charities. However, where leases contain gifted or subsidised elements, the accounting becomes more complex—requiring careful separation of commercial and donated components.
For many charities, the key challenge will be not just compliance, but ensuring that the financial statements continue to clearly communicate the underlying economic reality: the combination of contractual obligations and charitable support.
For support with your charity audit please contact Millet Audit on info@milletaudit.com