Introduction
The Financial Reporting Council have amended Financial Reporting Standard 102 (‘FRS102’) to incorporate updated requirements when accounting for lease contracts (Section 20 of FRS102). There are minimal changes for lessors, so this article concentrates on the position of the lessee’s perspective, with the key objective being to introduce you to the forthcoming changes that are effective for accounting periods commencing on or after 1 January 2026.
The revisions to FRS102 all but bring to an end the accounting distinction between operating and finance leases, and although they offer limited criteria-dependent exceptions, there is no doubt that those agreements captured by the new requirements will be subject to significant changes in the way they are accounted for.
The exceptions available relate to short term leases and low-value assets. For these purposes, short term leases are those covering a period up to 12 months, containing no purchase option. The assessment of low value assets is performed on an absolute basis: leases of low-value assets qualify for exception from the new provisions regardless of whether those leases are material to the lessee. Furthermore, the value of lease payments has no bearing on the assessment of whether an underlying asset is of low value. Examples of such assets include, inter alia, computers, small office furniture and printers.
Leases falling within the scope of the changes must be accounted for such that the balance sheet includes a lease liability, reflecting the present value of the future lease payments due over the lease term, and a corresponding asset, referred to as a ‘right-of-use’ asset.
Over the term of the lease, the lease liability will reduce by the lease payments made. The reversal of the ‘discount’ applied at the inception of the lease is charged to the profit and loss as an interest expense. Depreciation and (where necessary) impairment provisions are applied to the right-of-use asset over the lower of the lease term and the asset’s useful economic life.
Did you know?
There is no requirement to restate the comparative amounts included in the financial statements when first adopting these changes, and micro entities that have adopted Financial Reporting Standard 105 will be unaffected.
We do not expect any significant changes to the tax liability. Instead of recording an operating lease rental charge, there will now be an interest expense and a depreciation charge for the right-of-use asset. Tax relief is generally expected to be available for both of these items.
Your Professional Services team at PK Group understand the challenges these changes present. Quite apart from understanding their complex nature, understanding too their financial impact on the profit and loss account and balance sheet is a key consideration.
For those businesses with bank debt, assessing how the changes may impact on loan covenants will require thought and preparation. Other areas of consideration include the impact on key performance indicators, future dividend payments and corporate and deferred tax calculations.
Get in touch today:
PK Group’s Professional Services team are here to support you when assessing, preparing for and implementing these changes.
For more information, please don’t hesitate to contact us via welcome@pkgroup.co.uk or by phone on +44 (0)20 8334 9953.
