FRS 102 Lease Accounting: A Guide To The Key Changes

On 27 March 2024, the Financial Reporting Council (FRC) issued significant amendments to FRS 102—the Financial Reporting Standard applicable in the UK and Republic of Ireland. These changes won’t take effect until periods beginning on or after 1 January 2026 and you might be thinking, that sounds like a 2026 problem.

We would argue that it’s crucial to start preparing and having up front conversations with your auditors and business advisors as early as possible as some the changes may have a material impact on your business, some of which you have even yet to identify.

Why are changes coming to FRS 102?

These amendments aim to bring FRS 102 more in line with international accounting standards. Key changes include:

• Revenue recognition aligned with IFRS 15: Revenue from Contracts with Customers.
• On-balance sheet lease accounting for lessees, following the guidance in IFRS 16.
• Changes to fair value measurement, uncertain tax positions, business combinations, and disclosure requirements.

While these updates may seem daunting, there are practical expedients available to simplify the transition. However, it’s essential that your business fully understands how these changes will impact your financial reporting, operations and funding arrangements before they come into force.

FRS 102 Key Changes: Lease Accounting

The most significant change in lease accounting is the requirement for lessees to recognise right-of-use (ROU) assets and lease liabilities on the balance sheet. This will change how leases are treated in your financial statements and will impact key financial metrics, including EBITDA.

What’s Changing:

• ROU Asset and Lease Liability: Both must be recognised on the balance sheet.
• Impact on P&L: Lease expenses will now be presented as depreciation (for the ROU asset) and interest (on the lease liability) rather than as operating expenses, which will directly impact EBITDA.
• Exemptions: Short-term leases and leases for low-value assets are exempt from this treatment.
• Simplifications to IFRS 16: These include using an “obtainable borrowing rate” instead of an “incremental borrowing rate” and extended guidance on defining low-value assets.

Transitional Arrangements:

• No Restatement of Comparatives: There’s no need to restate prior period financials.
• Group Reporting: Businesses can use IFRS 16 carrying amounts as opening balances when transitioning to FRS 102.
• Balance Sheet Recognition: The ROU asset is recognised as equal to the liability on transition, with any cumulative effect of the initial application adjusted in opening retained earnings (unless exempted).

FRS 102 Key Changes: Revenue Recognition

The new amendments introduce the five-step revenue recognition model from IFRS 15, which requires businesses to assess contracts with customers more rigorously. This could significantly affect how and when you recognise revenue.

What’s Changing:

• Five-Step Model: You’ll need to evaluate each revenue contract through the lens of the five-step model. This could lead to changes in the timing of revenue recognition.
• Complex Contracts: For contracts with multiple performance obligations, warranties, customer options, or significant financing components, the treatment may differ from your current practices.
• Simplifications:
  • You may apply the five-step model to a portfolio of similar contracts, simplifying the recognition process.
  • There are simplifications for allocating discounts, and the new disclosures align with IFRS for SMEs, ensuring transparency and consistency.

Transitional Arrangements:

• You have two options:
  1. Restate Comparatives: Adjust your prior-period figures to reflect the new model.
  2. No Restatement: If you choose not to restate comparatives, any cumulative effect will be recorded as an adjustment to opening retained earnings.

6 Ways The FRS 102 Changes may Impact Your Business

The impact of these changes will vary depending on the nature of your business, but it’s likely to be more far-reaching than you initially think. Below are a few key considerations for your business:

1. Impact on Financial Metrics- How will the changes to lease and revenue accounting affect key metrics such as EBITDA, profit, and net debt? This will be critical for financial reporting and decision-making.
2. Impact on Performance-Based Schemes- Will these changes affect remuneration or bonus schemes linked to financial performance metrics? For instance, a reduction in EBITDA could impact executive bonuses or employee incentives.
3. Dividends and Reserves- Could changes in accounting lead to a reduction in distributable reserves? This could affect your dividend policy and payout schedules.
4. Managing Variable Consideration- If your business has contracts with variable consideration (e.g., contingent payments or performance-based pricing), how will the new rules on revenue recognition impact your forecasts and contract management?
5. Systems and Controls- Do your current systems and controls support the new requirements? Consider whether your existing financial reporting systems will handle the changes smoothly or if upgrades are necessary. Training your team is essential to ensure they understand and implement these changes correctly. This was one of the key challenges my clients faced when the transition to IFRS 16 occurred back in 2019.
6. Proactive Steps- What can you do now to simplify the transition? Consider reviewing your contracts to clarify terms and reduce future complexity. Conduct a completeness check over your lease population to assess the impact and build a project plan to ensure a smooth transition.

NEXT STEPS NECESSARY TO Prepare FOR FRS 102 CHANGES?

The prospect of implementing these changes may seem complex, taking a proactive approach and planning ahead will make the transition much smoother. A clear  plan, dedicated team  and proactive steps might be the key to minimising disruption and ensuring your business remains compliant.

Here are a few steps to consider:

• Set up a Project Team: Appoint a team to lead the transition, involving key stakeholders from finance, operations, and IT.
• Engage Early: Start reviewing contracts and systems now to identify any areas that may need adjustment.
• Focus on Training: Make sure your finance team is trained on the new requirements and understands how to implement them.

The changes to FRS 102 are significant, but with the right approach, your business can manage the transition smoothly. If you would like to discuss how these amendments may impact your business or need support in navigating the changes, don’t hesitate to get in touch with Jordan Taylor, Alexandra Wheelan or your usual AAB contact.