Future lease accounting changes businesses need to prepare for
The Financial Reporting Council (FRC) has approved changes to UK accounting standards, effective for accounting periods beginning on or after 1 January 2026.
One of the most significant amendments is to lease accounting under Section 20 of FRS 102. Below, we outline the principal changes, their financial and tax impact, and the steps businesses should take to prepare.
What are the key lease accounting changes in FRS 102?
Under the revised standard, all significant leases must be recognised on the balance sheet. This removes the current distinction between finance and operating leases. Most leases will now be brought onto the balance sheet, with only two key exemptions:
- Short-term leases; and
- Leases of low-value assets.
Financial reporting impact
These changes will have a direct effect on reported results and financial performance measures:
- EBITDA will increase, as operating lease costs are no longer deducted from earnings. Instead, businesses will recognise depreciation of the right-of-use asset and interest on the lease liability.
- While the total profit impact over the life of the lease remains the same, costs will be front-loaded – higher in the early years, lower towards the end.
- On the balance sheet, both an asset and liability will be recognised, making it difficult to estimate the impact on debt calculations.
- Businesses are likely to see an initial reduction in net assets, which will unwind over the lease term.
These changes could affect banking covenants, performance-related bonus schemes, and other contractual arrangements. They will also require clear communication with stakeholders who rely on EBITDA and debt metrics.
Peppercorn leases
It should be noted that ICAEW have confirmed that peppercorn leases are considered to be a lease, but with zero or nominal consideration. These types of lease are unlikely to meet the FRS 102 definition but are considered to be a form of non-exchange transaction and will be treated in accordance with FRS 102 section 34. A peppercorn lease is a legally binding lease that requires only a nominal rent to be paid annually, to satisfy the requirement for consideration in contract law.
Exemptions
There are exemptions available for certain low-value assets, such as mobile phones, small office furniture, and short-life leases of less than 12 months. They can still be accounted for as under the old treatment, with payments being expensed via the profit and loss account.
If a company is a subsidiary of a group whose consolidated financial statements are prepared under IFRS, they are able to use the right of use asset and lease liability calculations currently prepared.
Tax impact
The amendments also create important tax considerations:
- The timing of tax cash flows may be impacted by the accounting changes if finance costs are front-loaded.
- Whilst the tax legislation broadly returns companies to the same tax position they would have been in had accounting rules not changed, the introduction of similar rules under IFRS 16 highlighted complex and sometimes unexpected outcomes, particularly around deferred tax.
- For capitalised operating leases (not classed as long funding leases), deductions will typically be available for depreciation and lease finance costs, but the timing of relief may differ from actual lease payments.
- Some depreciation charges may relate to non-deductible expenses (e.g. lease premiums, stamp duty, property restoration costs), requiring careful review.
Early engagement with tax advisors is essential to assess both the initial and ongoing impact and ensure compliance.
How should businesses prepare?
Key steps include:
- Engaging stakeholders early – lenders, investors, and management teams will need clear explanations of the impacts.
- Identifying affected contracts and leases – this may be a significant project depending on the volume and nature of leases.
- Assessing accounting impacts – including the effect on P&L, balance sheet, EBITDA, and covenants.
- Reviewing tax consequences – working with advisers to model adjustments and timing differences.
- Considering systems and processes – some businesses may require new software to handle lease accounting efficiently.
We’re here to help
Our specialist team can guide you through the upcoming changes to lease accounting and wider amendments to UK Generally Accepted Accounting Practice (GAAP). If you would like to discuss how these changes may affect your business, please get in touch with us using the form below.
