There are significant updates coming under FRS 102, particularly for lessees in Section 20 – lease accounting. All employees of companies that report under FRS 102 and work with leases will be impacted by these changes, especially those involved in preparing financial statements. For many, this might feel like déjà vu if you went through the IFRS 16 transition, as the lease accounting changes to FRS 102 aim to mirror what IFRS 16 did to IAS 17.
In this post, we’ll take a closer look at what these changes entail and their implications for your business.
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How FRS102 is Changing Operating and Finance Leases
One of the most significant shifts is that FRS 102 is eliminating the distinction between operating and finance leases. Previously, operating leases were not recorded on the balance sheet and were recognized as rental expenses over the lease term.
Starting 1 January 2026, however, most leases will need to be recorded on the balance sheet. This change means lessees will need to recognize a right-of-use asset and a corresponding lease liability for all leases, with a few exceptions for short-term leases and leases of low-value assets. This change is intended to give a clearer picture of a company’s financial obligations and assets.
What Do The Lease Accounting Under FRS 102 Changes Mean for Your Financial Statements?
Bigger Balance Sheets
Expect your balance sheet to show more assets and liabilities. This could affect various financial metrics, like your debt-to-equity ratio, which in turn could impact any debt or pension covenants. Balance Sheet performance ratios will further be impacted because you will only create a non-current asset but recognised a current and non-current lease liability.
Income Statement Changes
Lease expenses will now be split into depreciation of the right-of-use asset and interest on the lease liability. This can result in a front-loaded expense pattern, impacting profit margins and key performance indicators.
Cash Flow Adjustments
The principal portion of lease payments will go under financing activities, and the interest portion will go under operating activities.
How You Can Prepare for the Lease Accounting Changes Under FRS 102
Embrace Early Adoption
You can adopt these changes early if you want, but you have to adopt all of them at once. The FRC has also provided some transition reliefs to make the process smoother.
Review Your Leases
This is probably the most important and initially the most time-consuming part. You need to create or review your lease portfolio data, including commencement and termination dates as well as payment terms for all your leases. Identify which ones are short-term leases and leases of low-value assets that qualify for exemptions. The exempt leases are effectively treated the same way operating leases are currently treated. All remaining leases are “finance leases” and, if you are not already accounting for them as such, they will need to be brought onto your balance sheet once the change kicks in.
Update Your Systems
Once you know how many new leases you need to account for, you’ll have a better idea of how to start. You can probably get away with using a spreadsheet if you only have a few leases, but for anything more than ten, you are probably looking at dedicated software or tools purpose-built for lease accounting. Most general accounting packages don’t have this built-in or fully supported.
Train Your Staff
Training your finance teams on the new requirements as well as the operations involved in leasing contracts will be crucial.
Communicate with Stakeholders
Be ready to explain these changes to investors, lenders, and anyone else interested in your financials especially considering the impact on performance ratios and other performance indicators relevant to your company.
How does lease accounting under FRS 102 compare with IFRS 16?
For most practical purposes, the new lease accounting requirements under FRS 102 and IFRS 16 are essentially the same. There are some exceptions, such as using an ‘obtainable borrowing rate’ instead of an ‘incremental borrowing rate.’ Additionally, there is some guidance on the definition of low-value leases that is missing from IFRS 16.
Final Thoughts on The FRS 102 Changes
These changes to FRS 102 aim to make lease accounting more transparent and consistent with international standards. While they might seem like a hassle at first, they’ll ultimately provide a clearer picture of your company’s financial health. Start preparing now to make the transition as smooth as possible. If all of this is new to you, looking at our IFRS 16 training is a great place to start, as well as our other blog posts.
How Can We Help These Changes?
Since IFRS 16 became effective in January 2019, large listed companies with big finance teams have struggled to account for their leases due to these changes. Most of them either started too late or built their own spreadsheets, which quickly became unmanageable. However, you don’t have to fall into the same traps. With good preparation and the right tools, you can succeed.
At Rubli, we have already helped numerous companies with successful IFRS 16 implementations and now we can do the same with FRS 102. We are geared to assist companies of any size, so get in touch today to see how we can help you.
