In what may to some sound like a rather dry accounting development, the Financial Reporting Council recently issued its latest version of Financial Reporting Standard (FRS) 102. This is no esoteric rule change: it has real-life implications for many businesses.
FRS 102 is the main accounting standard which affects most businesses. In an effort to align it more closely with international standards, the FRC has made some important changes to it, one of the most important of which is how leased asserts are reported on balance sheets.
The new standard comes into effect for reporting periods starting on or after 1st January 2026, which means that December 2026 year-ends will be the first period affected, except for those with a shortened reporting period starting after the beginning of this year. Early adoption is also permitted.
Whilst changes to revenue recognition outlined in the new standard may impact heavily on some businesses, potentially those with more complex customer contracts or businesses providing bundled goods or services, it is lease accounting which will have the greater effect for most companies. Essentially, the new FRS 102 looks to bring operating leases onto the balance sheet, which is a big change to how most businesses have accounted for them in the past.
This is not some obscure accounting nicety; it is a real-world, everyday issue. Currently, when you rent an asset under an operating lease, the lease charge hits your P&L each month on an ongoing basis. The new standard requires such assets to be capitalised on the balance sheet and depreciated over the lease term, with an opposing liability which reduces as you make repayments across the lease term, incurring an associated finance charge.
There are a few exceptions, for short-term (less than 12 months) leases, and for low value leases. But we should expect that most will need to appear on the balance sheet under the new rules.
Whilst the corresponding credit means that the initial consequence for the balance sheet at the bottom will be broadly neutral, that does not mean that there won’t be impacts in other areas. For example, it will most likely result in increases to EBITDA and interest costs, which can impact on metrics used for various purposes including bank covenants.
Just as importantly it will have the effect of increasing the value of the company’s gross assets. This is one of the three key tests (along with turnover and employee numbers) as to whether a business can be regarded as medium or large. This could potentially result in additional disclosure requirements and mean that statutory audit thresholds are breached.
There are also implications for corporation tax. Whereas previously there was a straightforward deduction from taxable profits for the rental expenses reported in the P&L, under the new standard, operating leases will move to having a depreciation cost and in interest expense, both of which will generally be deductible for corporation tax purposes.
Companies will need to ensure that leased assets are tracked separately to other tangible assets to ensure the correct tax treatment is applied.
As ever, seeking professional advice is vital to ensure you don’t fall foul of the new accounting standard. It is certainly worth starting to do this now, so it is not a big shock when you get to the end of the year, even for those who have not yet started a new reporting period under the new rules.