Top tips: lease accounting changes to FRS 102

Saskia Harrison, ACA, Audit director, Gerald Edelman - Croner-i

As a major overhaul of UK GAAP lease accounting rules come into effect from January, Saskia Harrison, audit director at Gerald Edelman explains the key issues from classification to right-of-use assets and depreciation considerations.

In March 2024, the Financial Reporting Council (FRC) issued amendments to FRS 102 as part of its Periodic Review 2024. The aim of these changes is to bring FRS 102 accounting in line with International Financial Reporting Standards (IFRS).

The effective date for these amendments will be periods beginning on or after 1 January 2026. However, companies can choose to be early adopters of these changes and apply them for periods beginning on or after 1 January 2025. If early adoption is applied, it must be applied to all the accounting standard changes, there is no option to be selective.  

For the first period in which the change in accounting standards applies, the prior period will need to be restated to be comparable. So, if, for example, your accounting year end is 31 December 2026, which will be the first year you are applying the changes, you will also need to restate 31 December 2025 to be comparable.

Therefore, if you have done so already, it is recommended to carry out the below assessment as soon as possible so that you can assess what the impact will be in the 2026 accounts for 2025 and 2026. 

This article will focus on the implications of the changes to lease accounting and treatment of disclosures in financial statements.

What are the changes to FRS 102? 

The main changes under the revised FRS 102 are:

• Accounting for leases as a lessee on the balance sheet, to align with IFRS 16 Leases;

• Revenue recognition, to bring this in line with the five-step model of IFRS 15 Revenue from Contracts with Customers;

• Supplier finance arrangements and new disclosure requirements;

• Fair value measurement, to align with IFRS 13 Fair Value Measurement; and

• Uncertain tax positions, to align with IFRIC 23 Uncertainty over Income Tax Treatments.

  
  

Key changes to lease accounting

Under the previous FRS 102 standards, leases were classified as either finance leases (recorded on the balance sheet) or operating leases (kept off the balance sheet). Under the revised rules, most leases will now be treated as finance leases, meaning they must be recognised on the balance sheet. 

The lease liability will need to be calculated based on the present value of the future lease payments. Therefore, a discount rate will need to be applied over the period of the financial obligation. If an implicit rate is known, then this should be used. If it is not, then businesses must use an incremental borrowing rate, or an obtainable market rate of borrowing. 

Each year, the asset will be depreciated in line with the period of the lease. The depreciation will reduce the asset, and increase the depreciation charge in the profit and loss (P&L), which was previously recorded as the rent expense recognised in the P&L.

The finance lease liability will then be unwound based on the payments made, and the unwinding of the discounted cashflow will be recorded as the finance cost in the P&L.

his in turn will reduce the amount of the loan. 

Are there any exceptions from these changes?

One of the exceptions will affect short-term leases, which are defined as leases with 12 months or less as at the date of commencement, and with no option to purchase the asset at the end of the lease.

If the short-term exemption has been taken for a lease, and either there is a lease modification or a change to the lease term (for example, a purchase option is exercised that was not considered reasonably certain), it will be classed as a new lease. 

Additionally, low-value asset leases, what is considered low-value will range from company to company. For example, one laptop may be considered low-value, but 1,000 laptops may not be. 

For these exceptions, they can continue to be accounted for in line with the previous FRS 102 accounting standards as operating leases.

How should these transactions be disclosed in financial statements?

Right-of-use assets must be clearly disclosed in financial statements to promote transparency and ensure compliance with the revised reporting standards. These assets can be presented either as a separate line item on the statement of financial position or grouped within property, plant and equipment (PPE), with separate disclosure in the notes.

If a right-of-use asset is more appropriately treated as an intangible asset, it should be included under intangible assets and disclosed separately in the notes to the accounts. For investment properties, right-of-use assets should appear within the investment property heading. 

Depreciation of these assets should be recognised in the income statement based on the asset’s use, typically under cost of sales or administrative expenses.

Lease liabilities should be presented separately on the face of the statement of financial position, or included with other liabilities, however there should be a note to separately disclose the lease liability balance held within other liabilities.

The expense side of this transaction (interest expense) should be included in the income statement under ‘Interest payable and similar expenses’.

What to do if the lease price includes multiple costs

If the lease of the asset has multiple elements to the cost (such as the use of the lease, but also the maintenance and service charges for it), then the entity must determine the relative stand-alone price of each part of the agreement, between the parts that relate to the lease, and the non-lease components.

If this is clearly separated in the pricing arrangement, then this will be straight forward to calculate. However, if it is all combined in one price, the entity must assess the price that the supplier would charge an entity for each separate component. The entity will then account for the lease component under Section 20, and non-lease components under the relevant section of FRS 102. 

When a lease includes more than just rental costs, such as maintenance or service fees, companies need to break down the total cost into its separate parts. 

If the pricing is clearly itemised, this is straightforward. If not, the company must estimate what each element would cost on its own. The lease portion is then reported under Section 20, while other services are accounted for under the relevant FRS 102 rules. 

What to expect in the future?

These changes represent more than a technical accounting update, they highlight an evolution in how UK businesses approach financial reporting. By aligning more closely with IFRS, the revised FRS 102 encourages greater transparency and enhances trust between businesses and regulators. 

As with any major accounting change, preparation will be key. Companies that take early action to assess the implications, update internal systems, and train finance teams will find themselves best positioned to implement the new standards smoothly.

Ultimately, these amendments to FRS 102 are not just about compliance, they provide an opportunity for organisations to strengthen the credibility and clarity of their financial reporting in an increasingly global marketplace.