FRS 102 lease accounting changes 2026

For lessees, the amendments to Section 20 Leases could have a significant impact, as most leases will be brought onto the balance sheet. For lessors, the changes are not expected to be significant. The amendments are intended to enhance transparency and comparability of financial reporting between companies.

Overview of key changes to lease accounting under FRS 102

The lease accounting requirements have been completely replaced with a new section that is based on IFRS 16 Leases.

Removal of the distinction between operating and finance lease arrangements

For lessees, the distinction between operating and finance lease arrangements has been removed, with all leases (with some exceptions) being recognised on-balance sheet.

Recognition of right-of-use assets and lease liabilities

Under the new requirements, a lessee is required to recognise a new right-of-use asset within fixed assets, which represents the right to utilise the underlying asset specified in the contract. Alongside this, there is a corresponding lease liability, which is measured at the present value of future lease payments. Initially, the right-of-use asset is measured at the amount of the lease liability, adjusted for any lease payments made before the start of the lease, any lease incentives received and initial direct costs.

Subsequently, the right-of-use asset will be depreciated over the remaining term of the lease. The lease liability is decreased by the lease payments and increased by the unwinding of the discount (the finance charge).

Changes to income statement presentation

The current rental expense recognised in relation to operating leases will be replaced with depreciation of the right-of-use asset, together with a finance charge arising from the unwinding of the discount on the lease liability. Although over the lease term, the charge to the income statement will remain the same, the timing of this will change, with a higher finance charge at the start of the lease as the lease liability unwinds.

Exemptions for short-term and low-value leases

Exemptions are available that allow short-term leases (leases of less than 12 months) and leases of low-value assets to remain off-balance sheet. These will continue to be accounted for in a similar way to operating leases under the existing standard.

Enhanced disclosure requirements

In addition to the above, the amendments also include enhanced disclosure requirements that are based on IFRS for SMEs.

Compared to IFRS 16, Section 20 Leases includes several practical simplifications, which include:

• Discounting using a lessee’s obtainable borrowing rate, as an alternative to the lessee’s incremental borrowing rate, which has proved challenging to calculate for clients applying IFRS 16. The obtainable borrowing rate may be available from the company’s existing lenders;
• Reducing the number of situations where a lease modification requires the determination of a revised discount rate;
• Offering the option of a simpler approach to recognising gains and losses on sale and leaseback transactions; and
• Providing a more permissive approach when determining low-value assets. IFRS 16 provides an indicative figure of $5,000, which is not replicated in Section 20 Leases. However, FRS 102 includes examples of assets which would not be of low value, such as land and buildings, vehicles and production line equipment.

How to prepare for FRS 102 changes ahead of 1 January 2026

The changes to Section 20 Leases will take effect for accounting periods beginning on or after 1 January 2026, with early application permitted, provided all other amendments to FRS 102 are applied at the same time.

Companies must apply a modified retrospective approach on the first-time application of the amendments. Under this approach, comparative period information is not restated; instead, a cumulative catch-up adjustment is recognised in retained earnings at the date of initial application, which for those companies with a 31 December year-end would be 1 January 2026.

There are several transitional provisions available on first-time application of the new requirements to simplify the transition process; some of which are optional and some are mandatory.

For those companies that group-report under IFRS, the provisions permit a lessee to use, at the date of initial application, the carrying amounts of its lease liabilities and right-of-use assets calculated under IFRS 16. This practical expedient is intended to provide efficiencies within groups and minimise measurement differences.

Impact of the FRS 102 changes

The changes to Section 20 Leases apply to all FRS 102 reporters, including those reporting under FRS 102 Section 1A Small Entities.

Almost all companies will be impacted to some extent, although those with a higher number of leases will clearly feel the greatest impact. Industries that saw a significant impact on the adoption of IFRS 16 included:

• Retail;
• Airlines;
• Shipping;
• Professional services;
• Healthcare; and
• Telecoms.

For those with a large number of leases, early planning is essential. All lease contracts will need to be identified, collated and analysed. During this time, a company may consider that the lease portfolio is large enough to warrant the implementation of new software, which will require additional time to implement.

Even those with fewer leases are likely to have accounting systems and processes that will need to be updated to some extent.

Companies can expect to see changes to their KPIs such as leverage ratios, profitability ratios and interest cover ratios, as lease liabilities are brought onto the balance sheet and the operating lease expense is replaced by depreciation and finance charges. This may impact the ability to meet existing banking covenants, in which case early conversations with lenders are advised.

For industries that heavily rely on leasing, the experience gained from implementing IFRS 16 shows that these changes can drive strategic evolution in financial management and decision-making. The adoption of IFRS 16 prompted many to reassess their leasing strategies to reduce the impact on their balance sheets. For instance, they began opting for shorter lease terms or choosing to purchase assets outright.

Companies must understand the impact of Section 20 Leases as early as possible to facilitate a smooth transition and effectively communicate the expected changes with stakeholders.

We have extensive experience advising clients on the adoption of new and revised accounting standards. We can offer an end-to-end, auditable, lease accounting solution tailored to your needs, that encompasses contract analysis, transitional adjustments, journal entries, monthly reporting and financial statements disclosures.