The Financial Reporting Council (FRC) has issued significant amendments to FRS 102, the Financial Reporting Standard applicable in the UK and Republic of Ireland, particularly concerning lease accounting. These changes, effective for accounting periods beginning on or after 1 January 2026, aim to enhance the quality and consistency of financial reporting by aligning more closely with international standards, specifically IFRS 16.
Key changes
The primary change in FRS 102 is the removal of the distinction between operating and finance leases for lessees. Under the new model, lessees must recognise most leases (except for low value assets or short-term leases) on the balance sheet as a right-of-use asset with a corresponding lease liability. This approach mirrors IFRS 16 but includes some simplifications to make it more practical for private entities. Key aspects of the new lease accounting model include:
- Right-of-Use Asset: Lessees will recognise a right-of-use asset at the commencement date of the lease, measured at the initial lease liability amount, adjusted for any lease incentives received, initial direct costs, and restoration costs.
- Lease Liability: At commencement of a new lease the liability is measured by discounting at the interest rate explicit in the lease. If the rate is not readily available, then the lease liability can be measured using the present value of future lease payments, discounted using either the lessee’s incremental borrowing rate or an obtainable borrowing rate.
- Subsequent Measurement: The right-of-use asset is depreciated over the lease term, and the lease liability is reduced by lease payments, with interest expense recognized on the liability.
Impact of the changes
The amendments will have a significant impact on financial statements, particularly for entities with substantial operating leases. Key impacts include:
- Balance Sheet: Recognition of lease assets and liabilities will increase total assets and liabilities, potentially affecting key financial ratios and covenants. This can also impact on whether a company crosses the new Companies Act small/medium size criteria. Further information can be found here.
- Profit and Loss: Lease expenses will be split between depreciation of the right-of-use asset and interest on the lease liability, which may result in higher expenses in the earlier years of a lease. This will impact the calculation of EBITDA. Further information can be found here.
- Cash Flow: Lease payments will be split between principal repayments and interest, affecting the presentation of operating and financing cash flows.
Effective date and transitional requirements
The new requirements become mandatory for accounting periods commencing on or after 1 January 2026, with early adoption permitted if all amendments from the periodic review are applied simultaneously.
Transitional provisions:
- Modified Retrospective Approach: Lessees are required to apply a modified retrospective approach on transition. This means measuring the lease liability at the present value of remaining lease payments and recognising a right-of-use asset equal to the lease liability, adjusted for any previously recognised prepayments or accruals.
- No Restatement of Comparatives: Entities are not required to restate comparative figures. Instead, the cumulative effect of initially applying the amendments is recognized as an adjustment to the opening balance of retained earnings on the date of initial application.
Subsidiaries that are already required to recognised Right-of-Use-Assets/ Lease Liabilities through their inclusion in consolidated accounts prepared under IFRS, applying IFRS16, can utilise those calculations on initial application as a practical expedient on transition
The amendments to FRS 102 represent a significant shift in lease accounting, bringing greater transparency and comparability to financial statements. Entities should begin preparing for these changes by assessing their lease arrangements, updating systems, and engaging with stakeholders to manage the transition smoothly.
If you have any questions or need further assistance with these changes, feel free to get in touch with the team.
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