FRS 102: Upcoming Changes to Lease Accounting

Significant changes are coming to lease accounting under FRS 102, effective for accounting periods beginning on or after 1 January 2026.

These amendments remove the long-standing distinction between finance leases and operating leases for lessees. With only a couple of exceptions, most leased assets will now appear on the balance sheet.

This means lessees will recognise a right-of-use asset and a corresponding lease liability, leading to greater capitalisation of leased assets and a more transparent view of lease commitments.

These changes bring FRS 102 more closely in line with the approach taken under IFRS 16, creating greater consistency and comparability across financial reporting frameworks.

Measuring the lease liability

At the start of a lease, the lessee will measure the lease liability at the present value of the lease payments that remain unpaid.

To discount these payments, the lessee should use the interest rate implicit in the lease (if this can be readily determined). If not, the lessee can instead apply either their incremental borrowing rate or their obtainable borrowing rate.

The key message the FRC is keen to get across is that this should not be over-complicated. Getting the obtainable borrowing rate, for example, could be as easy as contacting the bank and asking them at what rate the business could borrow money. However, it’s important to retain evidence of how this rate was determined, as your auditor may request supporting documentation.

Lease payments included in the measurement of the liability will typically cover:

• fixed payments (less any lease incentives receivable),
• variable payments linked to an index or rate,
• any amounts expected under residual value guarantees,
• the exercise price of a purchase option (if reasonably certain to be exercised), and
• penalties for early termination, where applicable.

Exemptions

Two important exemptions mean not every lease needs to appear on the balance sheet:

1. Short-term leases – those with a term of 12 months or less at the start date, provided there is no purchase option.
2. Low-value assets – leases for smaller items such as office equipment, computers, or tablets may qualify. However, assets such as vehicles, machinery, aircraft, land, and buildings would not be considered low-value.

Transitional arrangements

Lessees are required to apply a modified retrospective approach on transition. Under this approach, a lessee must not restate its comparative figures and, instead, it recognises the cumulative effect of initially applying the amendments as an adjustment to the opening balance of retained earnings on the date of initial application.

What this means for you and your business

The revised standard will bring more leases on balance sheet, increasing both reported assets and liabilities. For many businesses, this will affect financial ratios, debt covenants, and reported profits, as lease expenses will now be split between interest and depreciation rather than shown as a single rental cost.

Preparing for the change

Businesses should start planning now by:

• Reviewing existing lease agreements and identifying which will be affected.
• Determining whether any qualify for the short-term or low-value exemptions.
• Considering how the changes may affect reported results, loan agreements, and budgeting.

Early preparation will make the transition smoother and avoid surprises when the new rules take effect.

Get in touch

If you’d like to discuss how these changes could affect your business, please contact us at Rayner Essex, we’ll be happy to help you prepare for the transition.