What the FRS 102 lease changes mean in practice?

It has been widely publicised that accounting for leases is changing under revised FRS 102. The change effective for accounting periods beginning on or after 1 January 2026, represents a shift from a model where future operating lease commitments were disclosed off balance sheet, to one where the vast majority of lease obligations are recognised within the financial statements as a Right of Use Asset and a lease liability.

A helpful simplification is no restatement of comparative figures is required. Therefore, Right of Use Asset and lease liabilities are recognised over the remaining lease payments from date of initially applying the standard. for example, from 1 February 2026 for a 31 January year end).

So what is in scope?

Except for leases that expire within 12 months or those that are low value, all leases previously accounted for as operating leases, will be in scope. And low value means exactly that i.e. typically less than £5,000 in value, small items such as laptops, mobile phones etc.

How are the balances calculated?

Once a complete lease register has been prepared, it is then necessary to discount the future lease payments to their present value.
However, in doing so some judgements need to be made:

1.) Borrowing rate

Determining the appropriate borrowing rate, particularly for SMEs without existing external borrowing will require some thought. Though there are useful external benchmarks for secured loans e.g. Sonia plus a margin. Alternatively, obtaining a quote from a bank for a secured loan over similar term will provide useful guidance.

This is important as the interest rate will not change during the life of the lease and are expected to use the same interest rate on leases with similar characteristics.

Equally, different assets will often justify a different borrowing rate, as a secured loan over 3-5 years for a van or a car, compared to that for a long-term property lease is likely to be different.

2.) Lease terms

Identifying the lease term is not necessarily straight forward, as leases often contain either break clauses or early termination clauses. Therefore, judgement will be required as to whether it is reasonably certain that one of these will be exercised. Here past actions will often be indicative of the future, i.e. for a property site, that is central to the operations of the business, on the balance of probabilities it’s reasonably unlikely to exercise a break in 5 years-time.

Whereas for other assets like cars, it could be more likely these clauses are used, for example by exercising an early termination clause on a car lease the business gains a technologically/economically better one as a result.

Having determined these, it will then be possible to discount the payments due under the lease to their present value.

Calculating the Right of Use

In addition to the present value of lease payments, there are a couple of main items to consider for the Right of Use Asset.

Firstly, if there is an existing lease incentive that has been recognised on the balance sheet, this will need bringing in and recognising against the Right of Use Asset.

Secondly, and this will be more applicable for new leases, are there any initial indirect costs relating to the lease? As it is possible to capitalise these within the Right of Use Asset, for example legal fees associated with negotiating the lease.

P&L implications

In the P&L, the existing operating lease rental charge will be replaced with the interest charge on the unwinding of the discounting of lease liability and the depreciation of the Right of Use asset. Therefore, whereas previously the cost profile was consistent over the lease term, under new FRS 102, there will be a front loading at the start of the lease term, as the interest charge will be higher at the start of the lease period than at the end.

Tax impact

A final consideration is deferred tax. Due to the differing profiles of depreciation on the Right of Use asset and the reduction in the lease liability from interest and rental payments, a timing difference emerges. As a result of this timing mismatch, it is common for a net deferred tax asset to arise in the early years of a lease. Ultimately, recognition of this may come down to whether the numbers are material, nevertheless it will be necessary to undertake the calculation to determine this.

Overall impact on the numbers

This change will significantly increase fixed assets and lease liabilities on the balance sheet. While in the P&L, where the operating lease charge was previously recognised, this is now split between interest and depreciation.

This will have a commercial impact when considering KPIs. As these changes will increase EBITDA when compared to previous periods. On the other hand, ratios such as interest cover, net debt, return on assets will fall. Therefore, engaging key external stakeholders e.g. lenders on covenants, will be important so the knock-on impact on KPIs is fully understood to arise from accounting changes rather than fundamental underlying performance of the business.

Overall, the move to on-balance sheet lease accounting under FRS 102 is more than just a presentational change and will require careful planning and judgement to implement effectively. Key decisions around lease terms, discount rates and the resulting deferred tax implications can have a meaningful impact on reported figures and performance metrics.

We recommend that businesses begin assessing the impact early and engage with their advisers to ensure a consistent, well-supported approach is taken, and that any resulting changes are clearly communicated to stakeholders.

If you would like more information or advice, please contact us.