New FRS 102: Amendments to lease accounting: Where should you start from?

Overview of the changes

Lessees are now required to recognise a lease liability on their balance sheet that reflects the promise to make future rental payments under the lease contract. At the same time, a corresponding right-of-use (ROU) asset is recognised, reflecting the exclusive use of the underlying asset over the lease term. These requirements apply to all leases except those agreed for 12 months or less (short term leases) and those relating to low value assets.

For lessees there is no longer a distinction made between operating and finance leases. Therefore, operating lease rental expenses as recognised under old FRS 102 are replaced by depreciation on the ROU asset and a finance charge on the lease liability.

The lease liability is initially measured at the present value of the future lease payments, discounted using one of three specified interest rates. The ROU asset is initially measured as the sum of the lease liability and specified adjustments for other costs.

Accounting by lessors has not been significantly changed.

 

What are the transition requirements?

• Restatement of comparatives is not permitted.
• If amounts have previously been calculated in accordance with IFRS 16 for group reporting purposes, the use of these amounts on transition is permitted.
• If not applying the group exemption, the ROU asset recognised is equal to the liability on transition, adjusted by the amount of any prepaid or accrued lease payments on the balance sheet before application of the amendments. Any cumulative effect of initially applying the standard is recorded as an adjustment to opening retained earnings.
• No requirement to disclose the impact on prior periods.

 

Where should you start from?

The effective date for the leases amendments is 1 January 2026 with early adoption permitted, while this seems far away, you will need to collect data, make and document significant estimates and judgements, and implement processes/systems/tools ahead of the date of transition. The earlier you begin to understand what impact the new standard may have on your entity, the better prepared you will be to resolve potential issues, reduce implementation costs and compliance risks. Here are some examples of questions to consider:

• What types of leases does the entity have? Are there any embedded leases within non-lease contracts?
• Do you have copies of all your lease agreements and are they available for review in order to identify and reflect key terms in the financial statement amounts?
• Does the finance team have the required knowledge on the new lease accounting requirements or is further training required?
• Are operating departments (eg facilities management) informed of the need to identify, collate and report to the finance team contracts that could potentially contain lease components?

 

What are the wider implications of the changes beyond accounting?

Entities are advised to conduct a thorough assessment to understand the full implications of these changes. This should include assessing potential impacts on the entity’s financial ratios, performance metrics, debt covenants, budgets, forecasts, business operations, systems, data, and internal controls. This comprehensive assessment will help identify implementation challenges associated with complying with the new lease standard beyond the accounting. Matters to consider include the following:

• Financial ratios and performance metrics: The effect of the change in lease accounting on financial ratios may trigger breaches in covenants or impact an entity’s credit rating for future lending, especially in respect of ratios such as interest cover, gearing, current ratios etc. Entities also need to assess how these changes affect other contractual arrangements where there is a link to performance, such as contingent consideration, performance related remuneration and employee bonus and share option schemes.
• Stakeholder awareness and communication: Timely assessment of metrics that impact internal and external stakeholders will facilitate proactive engagement with stakeholders if needed. Entities may need to dedicate more time to communicating and explaining their financial position and performance to stakeholders as key ratios such as EBITDA and gearing may be different upon adoption of the new lease standard.
• Lack of comparability with prior year financial statements: As comparatives are not restated upon initial application, the cumulative effect is recorded as an adjustment to opening retained earnings. Whilst this may have practical and implementation advantages, it creates lack of comparability between the current and prior periods. Entities should proactively engage its stakeholders to explain the lack of comparability before KPIs, budgets and forecasts are set and agreed.
• New IT systems, process and controls needed for adoption: For entities with high number of material operating leases, timely assessment of the system gaps and business and IT requirements will support the software vendor selection process for a lease software solution and any decision to outsource the lease accounting process completely. This will help reduce reporting and compliance risks.
• Tax consequences: The revised standard may have a broad impact on the tax treatment of leasing transactions, to the extent your entity’s accounting profits are used as the basis for determining taxable profits, tax cash flows will be affected. Similarly, where taxation of leases does not follow the accounting treatment there will be deferred tax consequences as your entity will be faced with the challenge of deferred tax accounting to account for the newly originated temporary differences in the financial statements.

 

The new lease standard may require substantial time and effort to identify all lease arrangements and extract relevant lease data, especially in groups with foreign operations that might be applying similar accounting requirements. Early preparation will help you understand the scale of the impact of the changes, minimise implementation costs and mitigate the risks of non-compliance.

If you would like to discuss how the amendments might impact your business and how BDO can help support your business through the transition to the new standard, please get in touch with our team.