For businesses preparing accounts under FRS 102, there are important changes on the horizon that will affect how leases are accounted for in the financial statements.
The impact of these will vary from business to business, with a larger impact on those that have a significant number of leases, or leases with significant non-cancellable commitments, that are currently treated as operating leases, whether that be for equipment, vehicles, or property.
The Financial Reporting Council (FRC) has made amendments to UK GAAP to bring more leases onto the balance sheet, the aim beingthat accounts will give a clearer picture of a business’s financial commitments than under the existing standard. These changes will also mean UK standards are more closely aligned with International Financial Reporting Standards (IFRS).
What’s changing?
Currently Section 20 of FRS 102 treats leases in two different ways depending on the nature of the lease:
- Operating leases (like rented office space or hired equipment) are usually shown only as an expense in the profit and loss account, with a disclosure added showing the total lease commitment cost in the notes to the financial statements.
- Finance leases (where you effectively own the asset) are shown on the balance sheet as an asset and a corresponding lease creditor.
Under the revised rulesthe distinction between operating and finance leases has been removed, meaning most leases will now need to go on the balance sheet, even if you won’t own the asset at the end of the lease term.
This means more businesses will need to:
- Recognise a right-of-use asset in the balance sheet, reflecting the exclusive use of the underlying asset over the lease term, and
- Record a corresponding lease liability, calculated as the present value of future lease payments, discounted using one of three specified interest rates.
When do the changes apply?
The new rules take effect for accounting periods starting on or after 1 January 2026, so the first accounting years impacted are likely to be 31 December 2026 year ends (though consideration may be needed for short periods or changes in accounting reference date, where the new rules may apply sooner).
Will the changes affect all leases?
Not necessarily. There are two key exemptions that many entities will be able to use:
- Short-term leases – lasting 12 months or less.
- Low-value leases – like some IT equipment or small office items.
These can continue to be treated as they are now (off balance sheet), which will reduce the impact for many businesses that use short term lease contracts or have low value leases.
There is no precise definition of a Low value lease given in the amended standard, so the assessment of a lease as low value will be entity specific and require professional judgement.
The standard does set out types of assets where the lease would not be treated as low value and this includes leases relating to Land & Buildings and Vehicles, which are the most common types of lease we see amongst our clients. As these can’t be treated as low value we will see leased office space and leased company cars appear on the balance sheet in the future, unless the lease is less than 12 months in duration.
What are the Transition Rules?
Entities will be required to apply the new accounting standard using a modified retrospective approach, meaning:
- Comparative information is not restated in the year of transition.
- An opening balance adjustment is made to retained earnings (or another equity component) to reflect the cumulative impact of the changes at the date of transition.
This will mean that the prior year profit and loss account and balance sheet figures remain unaltered, with the changes only reflected in the current period figures on transition.
What will the changes mean in practice?
The key implications for businesses that lease assets are :
- The balance sheet will look different – there will be more assets and liabilities recognised as a result of the changes.
- The profit and loss account may show higher expenses earlier in the lease term than under existing rules. This is because under the amended rules the costs recognised are split between depreciation of the asset and interest on the lease liability, which will reduce over time.
- There may be a lack of comparability with figures for earlier periods. It is not permitted to restate the comparative figures on transition, meaning the changes could result in significant differences between the current and prior period figures in the period of transition. These changes may need to be explained to key stakeholders, so they understand the reasons for the variances.
- Key ratios like EBITDA, interest cover or gearing could change, which may affect loan covenants or other contractual relationships, such as performance related remuneration or share option schemes.
- You’ll need to gather more detailed information on your leases including payment terms, renewal options and discount rates in order to calculate the present value of lease obligations.
What should you do next?
✅ Review your lease agreements – Identify which leases will be affected and gather information needed to enact the changes.
✅ Talk to us – We can help you assess the impact and explain what changes (if any) you need to make to your accounting systems or records.
✅ Plan ahead – If your business has loan covenants or makes decisions based on EBITDA or other ratios, it’s worth understanding how those could be affected by the changes and whether action is needed to mitigate any risks that may arise as a result of the change.
Final thoughts
This change brings FRS 102 closer to international accounting standards, but the FRC has included sensible simplifications to keep the process manageable for SMEs. For those entities with a large number of leases, complex contracts or loan covenants to consider, early preparation will be key to ensure that any risks are identified, with sufficient time for these to be addressed before the change comes into effect.