Amendments to FRS 102, effective for accounting periods beginning on or after 1 January 2026, will significantly reshape how many UK businesses present their financial performance. One of the most consequential updates is a substantial overhaul of lease accounting, bringing FRS 102 much closer to the IFRS 16 model. While the revisions represent an accounting change rather than an economic one, they will materially influence business valuations, investor perceptions, lending discussions, and financial decision‑making.
Moving to on-balance sheet lease accounting
Under the previous FRS 102 framework, operating leases were treated much like any other overhead. Lease payments were recognised directly in the profit and loss account, reducing EBITDA, and future commitments appeared only in the notes to the financial statements. This meant that many businesses—particularly those in sectors with heavy property or equipment usage—carried substantial off‑balance‑sheet obligations that were not reflected in their reported liabilities.
The revised FRS 102 model eliminates the distinction between operating and finance leases for most arrangements. Instead, businesses will now recognise:
- a right‑of‑use (RoU) asset, representing their right to use the leased asset; and
- a lease liability, representing the present value of future lease payments
The move to capitalising leases on the balance sheet will be particularly significant for sectors such as retail, hospitality, transport, and leisure, where long-term leasing arrangements are common. These businesses will see an increase in both assets and liabilities, potentially altering key ratios such as debt‑to‑equity and gearing.
Impact on the profit and loss account
Shifting leases onto the balance sheet also changes how lease costs appear in the profit and loss account. Instead of rental expenses, companies will now record:
- depreciation of the RoU asset; and
- interest expense on the lease liability
Because the rental expense previously reduced EBITDA, the new structure often results in a higher EBITDA figure, even though underlying cash flows have not changed. This uplift will be most notable in businesses with significant leasing arrangements.
What does this mean for valuations?
If the revised standard primarily affects accounting presentation—not cash generation—why does it matter for valuation?
Equity value vs enterprise value
Fundamentally, the changes should not alter equity value, because the economic substance of the business is unchanged. However, many valuation approaches focus on enterprise value (EV)—the combined value attributable to both debt and equity holders.
Enterprise value is typically calculated as:
EV = Market value of equity + Market value of debt
By bringing lease liabilities onto the balance sheet, the level of reported debt increases. All else being equal, this mechanically increases enterprise value. The underlying business has not become more valuable; rather, the way its obligations are reported has changed.
Comparability and benchmarking challenges
One of the most significant challenges arising from the amendments is the impact on comparability:
- Trend analysis: When comparing results across multiple years, pre‑2026 reported metrics will not be directly comparable with post‑2026 figures unless adjustments are made.
- Peer benchmarking: Not all companies will transition in the same way or at the same time, and some may apply exemptions. EBITDA multiples, leverage ratios, and discount rates used in valuations must therefore be interpreted carefully.
For organisations involved in acquisitions, disposals, investment analysis, or performance‑based remuneration schemes, ensuring like‑for‑like comparisons will be essential.
Ensuring accurate valuation in the new environment
To maintain robust and meaningful valuations, businesses should:
- Normalise EBITDA and EV metrics to adjust for the impact of capitalised leases
- Review debt covenants as increases in reported liabilities may affect compliance
- Update valuation models ensuring the treatment of leases is consistent across comparable companies
- Communicate transparently with boards, investors, and lenders about the expected impact on financial statements
Conclusion
The forthcoming changes to FRS 102 represent a significant evolution in UK financial reporting. By bringing most leases onto the balance sheet, the standard enhances transparency but also alters key performance metrics that feed directly into valuation processes. While equity value should remain fundamentally unchanged, enterprise value, EBITDA‑based multiples, and financial ratios will look different.
For businesses, investors, and valuers alike, the priority will be ensuring consistency, clarity, and comparability. With careful adjustment and clear communication, organisations can navigate the transition effectively and maintain confidence in the financial information used to support key commercial and strategic decisions.
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