Changes to Lease Accounting Under FRS 102Written on March 19, 2026 by Kirk Rice LLP
Key Points
- Almost all leases must be recognised on the balance sheet as a right-of-use (ROU) asset and a lease liability representing future lease payments, moving away from the distinction between operating and finance leases.
- At commencement, the lease liability is measured at the present value of future lease payments, with a matching ROU asset adjusted for prepayments, incentives and direct costs.
- Lease accounting replaces rental expense with depreciation of the ROU asset and interest on the lease liability over the lease term.
- Businesses may see higher assets and liabilities, higher EBITDA, more front-loaded expenses, increased gearing, and changes to cash flow classification.
- Exemptions apply for short-term leases and low-value assets, with transition using a modified retrospective approach and no restatement of comparatives.
The amendments mainly affect lessees, moving away from the traditional distinction between operating and finance leases to a single on-balance sheet model more in line with provisions in the International Financial Reporting Standards.
What’s changing?
Previously:
- Finance leases were recognised on the balance sheet.
- Operating leases were expensed as rent and kept off the balance sheet.
Under the revised standard:
- Almost all leases must be recognised on the balance sheet as:
- a right-of-use (ROU) asset, and
- a lease liability representing future lease payments.
This approach aligns FRS 102 more closely with IFRS 16 and improves transparency over lease commitments.
How will leases be accounted for?
At commencement:
- Measure the lease liability at the present value of future lease payments.
- Recognise a matching ROU asset, adjusted for prepayments, incentives and direct costs.
Afterwards:
- Depreciate the ROU asset over the lease term.
- Recognise interest on the lease liability.
- Replace rental expense with depreciation + finance cost.
Practical effects on financial statements
Businesses may see:
- Higher assets and liabilities
- Higher EBITDA (rent no longer in operating costs)
- More front-loaded expenses
- Increased gearing, which may affect covenants
- Increased need for an audit
- Changes to cash flow classification
Exemptions
Entities can still expense payments (no balance sheet recognition) for:
- Short-term leases (12 months or less)
- Low-value assets
Transition
A modified retrospective approach applies:
- No restatement of comparatives
- Adjustment made to opening reserves at adoption
Lessor accounting
Accounting for lessors remains largely unchanged.
The new lease model will give a clearer picture of lease obligations but may significantly affect reported performance and ratios. Businesses should prepare early by identifying all leases, assessing systems, and considering the impact on covenants and KPIs. Contact us via info@kirkrice.co.uk
Please note: This article is correct as at the publication date. The answers are given for general guidance only and specific advice should be taken before acting on any of the suggestions made. The information is based on current tax legislation which may change in future. Information is based on our current understanding of taxation legislation and regulations. Any levels and bases of relief from taxation are subject to change. The Financial Conduct Authority does not regulate tax planning.
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