Changes to lease accounting
Amendments to FRS 102 which come into effect for periods commencing on or after 1 January 2026, will have a considerable impact on how leases are accounted for lessees. The accounting for lessors is unchanged.
Currently, leases are split between operating leases and finance leases, with operating lease payments taken straight to the P&L, and finance leases capitalised.
This distinction is being removed, meaning far more leases will be recognised in the balance sheet of companies, like they currently are with finance leases. A right-of-use asset is recognised and depreciated, and a corresponding lease liability is recognised and interest charged over the lease term.
There are a couple of exemptions, namely low-value assets (not leases) or short-term leases (12 months or less). So leased laptops, phones and small items of furniture are likely to still be expensed, but 12 month+ car hire agreements and property rentals are all required to be capitalised going forward.
There are no changes to lease accounting for micro-entities under FRS 105.
What does this mean?
The recognition of right-of-use assets will increase many companies’ gross assets. This could move some entities from being small to medium and could impact their audit requirement.
Rent expenses will be replaced with depreciation of the right-of-use asset, and there will be increased interest expenditure from the unwinding of the lease liability.
Overall the expense will still be the same over the life of the lease, but it’s likely that more expenditure will be recognised in earlier periods as the finance liability is unwound.
What should can we do to prepare?
Firstly, you should look at what leases your company has and split them into exempt leases and non-exempt leases. For the non-exempt leases that now must be capitalised, consider the information required to account for the changes:
- The valuation of the right-of-use asset will be needed, for something like a car. This is relatively straightforward, but for something like a property, this might be something you will need to consult an expert on.
- The interest rate applied on the lease liability should be that implicit in the lease (i.e. implied interest that makes the present value of the lease payments equal to the fair value of the asset), or if that cannot readily be determined, then the lessee’s incremental borrowing or obtainable borrowing rate should be used.
Will I need to restate comparatives?
No, FRS 102 does not allow the restatement of comparatives, so adjustments will be taken to reserves at the beginning of the first year under the new standard. This is practically a bit easier, but will mean a lack of comparability between say the 2026 and 2025 figures, where one will have a right-of-use asset and the other will not.
Get in touch
If you need further guidance on the changes and how they will impact your business, please contact one of our directors: info@wtca.co.uk