In the UK, FRS 102 is the key financial reporting standard for small and medium sized organisations.
The Financial Reporting Council issued amendments to FRS 102 in March 2024. Most of these changes will affect accounting periods beginning on or after 1 January 2026.
A notable change will alter the way lessees treat leases in their accounts.
Finance & operating leases
A finance lease is where an asset (vehicle, machinery, etc.) is loaned long-term and transfers most ownership risks/rewards to the lessee, who makes payments covering the asset’s full value plus interest. These leases often include an option to buy the asset at the end for a reduced fee.
An operating lease is where an asset is rented for a set period, where the lessor keeps most ownership risks/rewards. The lessee pays to use it, returning when the lease expires, not buying it.
Currently, finance leases are recognised on the balance sheet as an asset and a liability. Operating leases do not have to be included on the balance sheet, and lease payments are recorded as an expense on the profit and loss/income statement.
What’s changing?
The revisions to FRS 102 will now mean most operating leases must be recorded on the balance sheet, excluding short leases (less than twelve months) and low value leases.
Lessees will now need to recognise both a right of use asset and a lease liability on their balance sheet, as well as account for depreciation and interest on each of these elements through the profit and loss account.
This will inflate the value of assets and liabilities on the balance sheet compared to the existing rules. Consequently, this will alter balance sheet metrics and possibly some profit and loss metrics too, affecting how your organisation’s finances appear. Initially, this may raise some questions from banks or other third parties, until the treatment is understood more universally.
Another effect of the changes will be that recognising right-of-use assets will increase the gross assets of an organisation. This could impact the size of the company, the audit obligations, and eligibility for certain reliefs and tax efficient measures.
How should your organisation act?
Document all your lease agreements consistently in one place. Ensure you are detailing terms, payment schedules, options and index clauses. Check non-lease contracts to see if they contain any hidden leases. When it’s relevant to your financial statements, it will be helpful to have all the information together.
Leases agreements might include assets such as:
- Buildings/facilities
- Vehicles
- IT equipment
- Office equipment
If you think that the change to your balance sheet and financial metrics will be significant, you may wish to communicate with key stakeholders (investors, lenders, employees) to explain.
If your organisation can be considered a micro-entity, it’s possible to avoid these lease changes by adopting FRS 105 instead.
Need some guidance?
Are you concerned by how these changes might affect your organisation? Please contact us and member of our team will be happy to explain what could happen and determine appropriate actions for you to take.
