Lease Accounting – Recent Amendments to FRS 102 (Effective from 1 January 2026)

The former IASB chairman Sir David Tweedie once famously bemoaned the fact that he had never flown on a plane that was on the airline’s balance sheet.

“One of my great ambitions, before I die, is to fly in an aircraft that is on an airline’s balance sheet.” – Sir David Tweedie

The Financial Reporting Council (FRC) has issued significant amendments to Section 20 of FRS 102, aligning it more closely with IFRS 16. Key changes include:

• Removal of the operating vs. finance lease distinction for lessees.
• Introduction of the right-of-use (ROU) asset model.
• Most leases now recognised on the balance sheet.

These changes aim to improve transparency in financial reporting.

The new requirements will be a significant change for FRS 102 reporters. Lessees are likely to face challenges finding and identifying leases, setting up systems and applying the judgements required by the revised Section 20.

How to calculate the liability and ROU asset under FRS 102

When a lease is deemed to be in scope for FRS 102 reporting, the lessee records both a right-of-use asset and a lease liability equal to the present value of future lease payments.

The right-of-use (ROU) asset and lease liability are then systematically accounted for throughout the lease term with the lease liability being akin to a loan. Each payment reduces the liability, but because payments are spread out over time, an interest expense is recorded separately.

To determine the present value of lease payments, lessees typically use the interest rate implicit in the lease. However, if this rate is not readily available, FRS 102 allows lessees to apply their incremental borrowing rate or their obtainable borrowing rate, i.e., the rate the lessee would expect to pay to finance a similar asset under similar terms. It is clear from the objective and the “choice” above that the rate implicit in the lease should be used if it can be readily determined. Only if it can’t be determined, can the lessee’s incremental borrowing rate be used instead.

The ROU asset is treated similarly to other tangible fixed assets, meaning it is depreciated over the shorter of the lease term or the asset’s useful life. This ensures that the cost of using the asset is spread out appropriately over time. This approach closely mirrors IFRS16, maintaining consistency in how lease assets are systematically accounted for.

Wider commercial, tax and covenant consequences

Bank covenants and KPI triggers: Covenant renegotiations may be required because debt and leverage metrics will worsen; proactive engagement with lenders is therefore essential.

Tax consequences: Capitalisation of leases may change taxable profits, allowances and timing of deductions; businesses should plan for corporate tax impacts.

Remuneration and performance metrics: Bonus schemes tied to EBITDA, ROA, or gearing may need recalibration to avoid unintended outcomes for employees and executives.

Business sale and earn-out: Earn-out arrangements may need to be reconsidered, if they hinge on certain profit targets.

Lack of comparability: Comparatives cannot be restated on initial application of the periodic review 2024, which means adjustments are taken to reserves at the start of the current year. While this may have some practical advantages, it creates a lack of comparability between the current and comparative periods.

With the effective date fast approaching, early planning and a structured implementation approach will be critical to ensure a smooth transition and compliance with the new requirements.

How Barnes Roffe can help

We appreciate that navigating changes in financial reporting can be challenging.

Our team of financial reporting specialists is on hand to support you with:

• Impact assessments tailored to your lease portfolio.
• Technical accounting advice on applying the revised lease accounting requirements.
• Discount rate and lease term evaluations.
• Transition planning and implementation support.

If you would like to discuss how the amendments might impact your business and how Barnes Roffe can help support your business through the transition to the new standard, please get in touch with one of our audit partners.

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