Effective from 1 January 2026
Introduction
The revised lease accounting requirements under FRS 102 come into effect for accounting periods beginning on or after 1 January 2026. These changes will significantly impact how leases are recognised, measured and presented in financial statements.
This guide provides a clear, client-focused overview of what is changing, what it means for your business, and the practical steps you should take now.
What’s Changing?
The most significant change is that most leases will now be brought onto the balance sheet.
Instead of distinguishing between operating and finance leases (as under the old rules), businesses will generally recognise:
- A Right-of-Use (ROU) asset (your right to use the asset)
- A Lease liability (your obligation to make lease payments)
This applies to most leases, with limited exemptions.
Who Is Affected?
The changes apply to:
- Medium and large entities reporting under FRS 102
- Small entities applying FRS 102 Section 1A
Not affected: Micro-entities applying FRS 105.
Key Exceptions
You may choose not to recognise leases on the balance sheet if they are:
- Short-term leases (12 months or less, with no purchase option)
- Low-value asset leases (e.g. laptops, phones, small office equipment)
Note: Cars, property and land do not qualify as low-value.
How Are Leases Measured?
Lease Liability
Calculated as the present value of future lease payments, using an appropriate discount rate.
Includes:
- Fixed payments
- Indexed payments (e.g. CPI/RPI at commencement)
- Expected payments under guarantees
Excludes: Usage-based or performance-based payments (expensed as incurred)
Right-of-Use Asset
Initially measured based on the lease liability and then:
- Depreciated over the lease term
- Reviewed for impairment where necessary
Determining the Lease Term
The lease term is not always just the contractual period. It includes:
- Extension periods you are reasonably certain to take
- Periods where you are unlikely to terminate early
This requires judgement and should consider:
- Business reliance on the asset
- Cost of relocation
- Leasehold improvements
Impact on Financial Statements
Profit & Loss
- Rental expense is replaced by:
- Depreciation
- Interest expense
- EBITDA typically increases
- Profit may be lower in early years of a lease
Balance Sheet
- Assets increase (ROU assets)
- Liabilities increase (lease liabilities)
- Gearing ratios may rise
Transition to the New Rules
- No restatement of prior year figures
- Adjustment made to opening reserves at transition date
- Practical simplifications are available
Key Business Impacts
1. Bank Covenants
Lease liabilities may increase reported debt and affect:
- Gearing ratios
- Net debt calculations
Action: Engage lenders early to review covenant implications.
2. Systems & Processes
You will need:
- A complete and accurate lease register
- Reliable calculation tools (spreadsheets may be risky for larger portfolios)
3. Tax
- Total tax relief is unchanged
- Timing differences may arise
- Deferred tax adjustments likely
Common Pitfalls to Avoid
- Incomplete lease population (especially embedded leases)
- Incorrect lease term assumptions
- Failure to update for CPI/RPI changes
- Spreadsheet errors in calculations
What Should You Do Now?
We recommend taking the following steps as soon as possible:
- Identify all leases (including embedded leases in service contracts)
- Build a lease register with key data (terms, payments, options)
- Decide on accounting policies (discount rates, exemptions)
- Assess system capabilities
- Model financial impact (KPIs and covenants)
- Engage with lenders and advisers early
- Train finance teams on the new requirements
How We Can Help
We can support you with:
- Lease population reviews
- Technical accounting advice
- Transition calculations
- KPI and covenant impact modelling
- Implementation support and tools
Disclaimer: This guide provides a high-level overview of the FRS 102 lease accounting changes effective from 1 January 2026. It does not constitute formal advice. Specific guidance should be sought based on your individual circumstances.
