In October 2024, we talked about the forthcoming changes to Lease Accounting under FRS102.

As businesses get ready for comparative year reporting, it’s important to refresh our memories on these changes and start preparing for the new rules that will kick-in for reporting periods commencing from January 1, 2026.

These updates are a big deal for lease accounting under FRS 102, making it more like IFRS 16, which has been around since 2019. The main change is that most leases will need to be included on the balance sheet, which will change how businesses report their financial positions.

Before, entities with operating leases could just treat lease payments as simple expenses in the profit and loss account. But now, the new rules recognise that these leases provide businesses with control over and benefits from the underlying asset. Relevant to companies, partnerships, and also charities, this change will make balance sheets more transparent by giving stakeholders a clearer view of financial obligations. However, it will also mean more administrative work and the need to adjust existing financial processes.

Currently rental payments under operating leases are treated as expenses in profit and loss accounts. Starting January 1, 2026, entities will need to capitalise most operating leases by recognising the present value of lease payments as ‘right-of-use’ assets. The corresponding lease liability will be the discounted future lease payments.

Key changes include:

• Depreciation of right-of-use assets over the lease term
• Replacing operating lease expenses with a depreciation charge on the asset and a finance charge on the liability
• Transition date requirements: Lease liabilities will be measured at the present value of remaining lease payments, discounted using the lessee’s incremental borrowing rate or an obtainable borrowing rate
• Companies already using IFRS 16 for group reporting can use existing carrying amounts under FRS 102 to ensure consistency across reporting frameworks, minimising discrepancies.

Summary of Financial Impacts:

• Assets: Increase due to recognition of right-of-use assets
• Liabilities: Increase because future lease payments are discounted and capitalised
• EBITDA and operating profit: Increase, as lease costs will be classified under finance costs instead of rent payments which would have been recognised within operating expenses.

These changes will affect a wide range of businesses, especially those that lease property, vehicles, or other high-value assets.

Actions you can take to benefit from the transition:

• Recalculate financial covenants to align with FRS 102 changes
• Engage lenders early to discuss covenant adjustments, or the use of ‘frozen GAAP
• Implement robust lease data systems to capture accurate lease information, borrowing rates, and lease terms
• Assess systems and processes now to ensure you are ready before January 1, 2026.

For assistance with these technical changes, feel free to get in touch with me or your usual Shaw Gibbs contact.

We’re here to help you navigate the new standards and ensure a smooth transition.