Significant revisions to Financial Reporting Standard 102 (FRS 102) are set to transform lease accounting for businesses across the UK and Republic of Ireland. Effective for accounting periods beginning on or after 1 January 2026, these changes will bring many leases onto the balance sheet and align UK GAAP more closely with international accounting standards.

For many organisations, the impact will go beyond accounting, influencing financial metrics, tax positions, and commercial decision-making.

A Fundamental Shift in Lease Accounting

One of the most notable changes is the removal of the distinction between operating and finance leases for lessees. Instead, most leases will now be recognised on the balance sheet through:

• a right-of-use (ROU) asset; and
• a corresponding lease liability

On transition, businesses are not required to restate comparative figures. Instead, the cumulative effect of adopting the new rules is recognised as an adjustment to opening retained earnings, simplifying the transition but still requiring careful calculation.

How Leases Will Be Measured

At the date of initial application, a lease liability is recognised based on the present value of the remaining lease payments. This is discounted using either:

• the lessee’s incremental borrowing rate; or
• an obtainable borrowing rate

The ROU asset is initially measured at an amount broadly equal to the lease liability, adjusted for upfront payments, lease incentives, and any initial direct costs such as legal fees.

Over the life of the lease, the accounting profile changes. The asset is depreciated on a straight-line basis, while a finance cost is recognised on the lease liability using the effective interest method. This results in a front-loaded expense pattern, with higher costs in the earlier years of the lease.

Most But Not All Leases Are Included

Despite the broad scope of the new rules, there are two key exemptions:

• Low-value assets — such as laptops, mobile phones, and small office furniture (but not vehicles, property, or heavy machinery)
• Short-term leases — leases with a term of 12 months or less, and no purchase option

While these exemptions may appear straightforward, applying them in practice will often require judgement.

Identifying Whether a Contract Is a Lease

A critical step under the revised standard is determining whether a contract is, or contains, a lease. This depends on whether the contract conveys the right to control the use of an identified asset in exchange for consideration.

Control exists where the customer:

• directs how the asset is used; and
• obtains substantially all of the economic benefits from that use

This assessment is particularly important as some arrangements previously treated as service contracts may now fall within lease accounting, and vice versa.

For example, serviced office agreements often remain outside the scope of lease accounting if the provider retains the ability to move the occupant to a different space. In these cases, the arrangement is more akin to a service contract rather than a lease.

Ongoing Reassessments

Lease accounting does not end at initial recognition. Reassessments may be required where there are changes to:

• lease terms;
• payment structures; or
• other contractual conditions

This introduces an additional layer of complexity and ongoing monitoring.

Tax Considerations

From a tax perspective, the change in accounting does not alter the overall tax outcome over the life of a lease. However, it does change the profile and nature of the deductions.

Under the new rules:

• the depreciation of the right-of-use asset is an allowable deduction; and
• the finance cost on the lease liability is also deductible

Because the finance cost is higher in the earlier years of a lease, the total tax deduction is typically front-loaded, with greater relief available at the start of the lease term and lower deductions in later years.

Although this creates a timing difference, the total amount of tax relief over the lease term remains unchanged.

Wider Business Implications

The impact of these changes extends well beyond the balance sheet. Bringing leases on-balance sheet will increase both assets and liabilities, affecting key financial metrics.

In particular, businesses may see:

• changes to gearing ratios and balance sheet presentation
• higher EBITDA, as operating lease costs are replaced with depreciation and interest
• altered profit profiles due to the front-loaded expense pattern

These changes can also affect loan covenants, bonus arrangements, and dividend planning. Early engagement with lenders and stakeholders is therefore essential.

What Should Businesses Do Now?

Businesses should take a proactive approach to implementation. Key steps include:

• identifying all lease arrangements, including those embedded in service contracts
• calculating lease liabilities and ROU assets using appropriate discount rates
• assessing the broader impact on financial reporting, tax, and commercial arrangements
• preparing for enhanced disclosure requirements under the revised standard

This is not simply a technical accounting exercise, it requires coordination across finance, tax, and operational teams.

Why These Changes Are Being Introduced

The revised lease accounting model is designed to improve transparency by ensuring that financial statements more accurately reflect a company’s obligations. Recognising leases on the balance sheet provides users with a clearer view of a business’s financial position.

Final Thoughts

The updates to FRS 102 represent one of the most significant changes to UK GAAP in recent years. While the technical requirements are important, the broader impact on financial reporting and business decisions should not be underestimated.

Early preparation and a well-planned approach will be key to a smooth transition.

Contact Us

If you would like assistance in understanding how these changes affect your business, or support with implementation, please contact us. Our team would be happy to help you navigate the new requirements and ensure you are fully prepared.