The landscape of financial reporting is undergoing a seismic shift that will impact many small and medium-sized enterprises (SMEs) across the UK and Ireland.
In Staying Ahead of the Curve - FRS 102 Update Essentials, Robert Kirk covered the implementation of the updated Financial Reporting Standard 102 (FRS 102), set to commence in January 2026, one of the most significant changes is the abolition of the operating lease for lessees. This blog post delves into what this change entails, its implications, and how businesses can prepare for this transition.
Understanding the Change
Traditionally, operating leases have allowed lessees to record lease payments as an expense on their income statement, without recognising the associated asset or liability on the balance sheet. This practice will soon become a relic of the past. The revised FRS 102 mandates that lessees include all leases, with few exceptions, on their balance sheets—reflecting both the right-of-use asset and the corresponding lease liability.
The Impact on Financial Statements
The removal of the distinction between operating and finance leases for lessees means that all leases will now be treated similarly to what were previously known as finance leases. This will result in a more accurate portrayal of a company's financial position, as it provides a clearer picture of the company's obligations and resources.
For SMEs, this could lead to a significant increase in reported assets and liabilities. The leased asset must be amortized—or as commonly referred to in practice, depreciated—over the lease term, while interest will represent the unwinding of the discount on the lease liability. Consequently, two separate charges will affect the profit and loss account: depreciation of the right-of-use asset and interest on the lease liability.
Operational Consequences
Beyond the balance sheet, the new standard will also alter how lease expenses are reported in the cash flow statement. Payments can no longer be classified simply as operating expenses; instead, the principal portion of lease payments will be recognised as financing outflows, reflecting the repayment of debt.
Preparing for the Transition
As the implementation date approaches, SMEs should begin to assess their current leasing arrangements and understand how these will be represented under the new standard. It's crucial to consider not only existing leases but also potential renewals and modifications that may occur over time, as these can affect the valuation of the right-of-use asset and lease liability.
Challenges and Considerations
One area of complexity arises from contracts that combine lease and service components, such as a car lease that includes maintenance services. The standard requires businesses to separate these elements, capitalising the lease while expensing the services. However, if the service element is insignificant, lessees can opt for simplicity and not separate the components.
Another challenge is the potential for "double counting" in group scenarios where a parent company leases an asset to a subsidiary, leading to consolidation adjustments.
The abolition of the operating lease for lessees represents a fundamental change in how SMEs will report their leasing activities. While some may view this as an administrative burden, it ultimately leads to greater transparency and comparability in financial reporting. Businesses are encouraged to engage with their accountants and auditors to ensure a smooth transition to the new standard. As we move closer to 2026, staying ahead of the curve will be vital for SMEs to navigate these changes successfully.
For the full session, please click here. This course features topics such as:
• Key recommended updates and amendments in FRS 102
• Q&A session
The contents of this article are meant as a guide only and are not a substitute for professional advice. The author/s accept no responsibility for any action taken, or refrained from, as a result of the material contained in this document. Specific advice should be obtained before acting or refraining from acting, in connection with the matters dealt with in this article.
