Introduction: The Financial Reporting Council (FRC) has issued amendments to FRS 102, which will come into effect for accounting periods beginning on or after 1 January 2026. Early adoption is also permitted for periods beginning on or after 1 January 2025. This article aims to provide an overview of the key changes and their implications for entities.

Key Changes: One of the significant changes made by the FRC is the revision of lease accounting, aligning FRS 102 more closely with IFRS 16 principles. This change requires companies to capitalise most leases on the balance sheet, which may significantly impact their financial position and various metrics.

Previous Standard: Under the previous standard, entities with operating leases would simply expense the lease payments in the profit and loss account, and any lease commitments at the year-end were disclosed separately in the financial statements (off balance sheet).

New Requirements:

Following the recent amendments, at the commencement date of the lease, a lessee is required to recognise a right-of-use asset and a lease liability. The right-of-use asset should be measured at cost, which includes the initial lease liability, any lease incentives received, direct costs incurred by the lessee, and any estimated dilapidation costs. The lease liability is the present value of the lease payments, discounted using the interest rate implicit in the lease or, if that rate cannot be readily determined, the lessee’s incremental borrowing rate.

Subsequent Measurement:

· Right-of-Use Asset: The right-of-use asset shall be measured at cost less any accumulated depreciation and impairment losses. Adjustments for remeasurement of the lease liability shall also be accounted for. If the right-of-use asset meets the definition of an investment property, it shall be held at fair value. Similarly, if the right-of-use asset relates to a class of property, plant, and equipment (PPE) for which the lessee applies the revaluation model, the lessee may elect to apply that revaluation model to the right-of-use asset.

· Lease Liability: The lease liability will be increased by the interest rate and then reduced by any lease payments.

Exemptions:

· Low-Value Assets: An asset can be considered low value if the lessee can benefit from it on its own or together with other readily available resources, and if the asset is not highly dependent on another asset. For example, computer equipment is likely to fall into this category.

· Short-Term Leases: A lease that, at inception, has 12 months or less to run is considered a short-term lease. The lessee should record the lease payments as an expense on a straight-line basis over the lease term or another systematic basis that more accurately represents the pattern of the lessee’s benefit.

Transition Adjustment:

The transition adjustments are designed to ease the shift to the new standard and do not permit a prior year adjustment. For any existing leases at the date of transition, a right-of-use asset and lease liability should be calculated for the remaining lease term and recognised accordingly. Any difference should be adjusted to the opening retained earnings.

Commercial considerations:

The change in approach will have a significant impact on the following:

· EBITDA is expected to increase as lease costs are moved from expenses to depreciation and interest. Therefore EBITDA will increase following the amendments.

· Net current assets are expected to decrease following the adjustment as the right of use asset sits in fixed assets whereas the current portion of the lease liability will be included in current liabilities.

· Gross asset are expected to increase and as such may push companies into the audit thresholds.

As a result care should be taken with banking covenants especially any relating to interest cover (as interest costs are likely to increase) and net debt considerations.

It’s important that entities understand the impact this will have on their financial statements and begin discussing these with key stakeholders such as investors, banks etc.

How can entities prepare?

1. Recalculate financial covenants to align with FRS 102 changes.

2. Engage lenders early to discuss covenant adjustments or the use of ‘frozen GAAP.’

3. Implement robust lease data systems to capture accurate lease information, borrowing rates, and lease terms.

4. Assess systems and processes now to ensure readiness by 1 January 2026.

5. Speak to us if you need any help.

Conclusion: The amendments to FRS 102 bring significant changes to lease accounting, aligning it more closely with IFRS 16 principles. Entities must understand these changes and prepare for their implementation to ensure compliance and accurate financial reporting