FRS 102 lease accounting: bringing leases onto the balance sheet

The changes to lease accounting are among the most significant for many companies as part of the periodic review of FRS 102, fundamentally changing how lease arrangements are recognised and presented in financial statements.

These are accounting changes first and foremost, but there are real-world implications which need to be considered and addressed, sooner rather than later.

Under the revised FRS 102 requirements, effective for accounting periods beginning on or after 1 January 2026, most leases will now be recognised on the balance sheet.

What's changing?

For businesses applying FRS 102, the distinction between operating leases and finance leases has largely been removed for lessees.

Instead, most leases now result in:

• A right-of-use asset being recognised on the balance sheet.
• A corresponding lease liability being recorded.

This means many businesses will see an increase in both total assets and total liabilities, potentially changing how their financial position is presented and assessed.

Why does this matter?

The changes could have a significant impact on several key financial measures, including:

• EBITDA calculations
• Management and employee bonus schemes
• Bank loan covenants
• Liquidity ratios
• Net asset positions
• Company size assessments

As rental expenses are generally replaced by depreciation and interest charges, EBITDA is likely to increase, even though the underlying lease cash flows remain unchanged.

Conversely, liquidity ratios will likely worsen, and any covenants linked to debt service ratios may be adversely affected.

Businesses should therefore consider how these changes may affect financial reporting, lending arrangements and performance-related targets.

Are there any exemptions?

Yes. Certain leases may continue to be accounted for without recognising a right-of-use asset and lease liability, including:

• Leases of low-value assets
• Short-term leases with a lease term of less than 12 months

However, businesses must carefully assess whether these exemptions apply, particularly when determining whether an asset qualifies as low value.

Areas requiring judgement

Several aspects of the revised lease accounting requirements will require careful consideration, including:

• Lease terms – including extension options, break clauses and termination rights
• Discount rates
• Low-value asset assessments

These judgements can significantly affect the value of lease assets and liabilities and the resulting P&L charges.

Early discussions with auditors and professional advisers can help businesses address potential challenges and avoid unexpected issues during the reporting process.

Preparation steps

I would recommend that businesses with significant leased assets take the following steps to prepare for the changes:

1. Compile a register of all lease arrangements.
2. Identify leases that may qualify for exemptions.
3. Determine appropriate discount rates.
4. Assess the potential impact on bank covenants and key financial metrics.
5. Engage with lenders early where covenant calculations may be affected.

For businesses with significant property, vehicle or equipment leases, understanding the financial implications and implementing the necessary accounting processes should now be a priority.

Taking a proactive approach will help businesses manage the transition, maintain compliance and ensure stakeholders understand the impact on reported financial performance.

Need help?

I recently recorded an episode of the Larking Gowen Insights podcast with James Nichols where we discussed this in more detail. You can listen wherever you get your podcasts, watch us on YouTube or click below to listen now.

If you have questions, our team would be happy to help. Get in touch with your usual Larking Gowen contact or email enquiry@larking-gowen.co.uk

Tom Dunston | Senior Manager in our Corporate Audit and Advisory team | Norwich, Norfolk