The lease accounting requirements under FRS 102 are changing fundamentally from January 2026.
Businesses that lease property, vehicles, equipment or other assets should begin preparing now to understand the financial reporting and wider business implications of these amendments.
Overview of the changes:
For accounting periods beginning on or after 1st January 2026, Section 20 (Leases) of FRS 102 introduces a new accounting model for lessees that brings UK GAAP more closely in line with the requirements of IFRS 16, which has applied to IFRS reporters since 2019.
Current treatment
Under the existing FRS 102 rules, leases are classified as either finance leases or operating leases.
- Finance leases transfer the risks and rewards of ownership to the lessee. The lessee recognises both an asset and a corresponding liability on the balance sheet, with depreciation and finance costs recognised in the profit and loss account.
- Operating leases do not transfer risks and rewards to the lessee. The lessee typically recognises rental payments as an expense over the lease term, with no balance sheet recognition.
Changes from January 2026
The amended Section 20 removes the distinction between finance leases and operating leases for lessees. Instead, lessees will be required to recognise all leases on the balance sheet by recording:
- A right-of-use (ROU) asset representing the lessee’s right to use the underlying asset
- A lease liability representing the obligation to make lease payments
The lease liability is measured at the present value of future lease payments. The ROU asset is depreciated on a straight-line basis over the lease term, whilst interest is recognised on the lease liability using the effective interest method.
Available exemptions
The amended standard provides optional exemptions for:
- Short-term leases: leases with a term of 12 months or less from the commencement date
- Leases of low-value assets: assets with a value when new of less than approximately £5,000
Where exemptions are applied, lessees may continue to recognise lease payments as an expense.
Impact of the changes:
Whilst these changes will affect the presentation of the financial position, they do not alter the underlying cash flows of the business. However, there may be impacts for business in:
Banking covenants and loan agreements
The changes to FRS 102 may have significant implications for financial covenants under existing loan agreements. Key metrics such as debt-to-EBITDA ratios, interest cover, and working capital measures may be materially affected by the new lease accounting treatment.
Businesses should engage proactively with lenders to discuss how covenants should be amended or frozen at existing GAAP to maintain appropriate thresholds.
Tax considerations
Both the depreciation charge on ROU assets and the finance cost on lease liabilities will be allowable deductions for tax purposes. However, the timing of tax relief will differ from the previous operating lease treatment:
- Finance costs are typically higher in earlier years and lower in later years, affecting the timing of tax deductions
- Transitional adjustments on adoption must be spread over the mean average length of the leases for tax purposes
- Deferred tax implications may arise from differences between accounting recognition and tax timing
Capital elements within ROU assets (such as stamp duty land tax) must be separately identified and tracked, as depreciation on these elements remains non-deductible.
For partnerships, changes in accounting profit may affect the amount and timing of partners’ tax payments. Companies should consider the impact on corporate interest restriction calculations and whether increased gross assets affect eligibility for tax reliefs such as the Enterprise Investment Scheme or Seed Enterprise Investment Scheme.
How Ormerod Rutter can help:
The team at Ormerod Rutter can support your business through this transition and offer advice on how this could affect your business.
The 2026 implementation date provides sufficient time for careful planning, but early preparation will ensure a smooth transition and enable effective management of the wider business implications.
If you would like to discuss how the FRS 102 lease accounting changes will affect your business, or to arrange an impact assessment, please contact us on 01905 777600, or email hello@ormerodrutter.co.uk.
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