Authors
Authors
In March 2024, the Financial Reporting Council (FRC) announced changes to UK GAAP, consisting of amendments to FRS 102, as well as other financial reporting standards. For the purposes of this article, we are focused on FRS 102 which, together with FRS 105, are the financial reporting standards that apply to all companies in the UK that do not apply International Financial Reporting Standards (IFRS). We highlight here two of the most impactful changes for business. These changes take effect from 1 January 2026 and the key takeaway from this article must be that businesses need to consider how these changes will work and how to incorporate them. In other words, it is time to prepare.
Lease accounting
From 1 January 2026, all leases will become “on-balance sheet”. Unless the lease falls into one of the exemptions, effectively the distinction between an operating lease (currently accounted for on the income statement) and a finance lease (accounted for on the balance sheet) no longer exists.
This treatment will not apply to leases of low value (i.e. where the underlying asset is of low value) or for leases with a term of 12 months or less. This change also only affects the lessee. Lessors are not required to amend the way in which they account for lease income.
In all other cases, the lease must move onto the balance sheet. This means that the balance sheet will show a right-of-use asset with a corresponding lease liability. Value of the right-of-use asset will be the present value of all future lease payments. The lease rental expenses are now replaced by depreciation on the right-of-use asset.
The notable consequences for businesses are to both the numbers and to tax.
The numbers
Bringing a lease onto the balance sheet will affect a number of metrics which businesses should be aware of. Examples of these are:
- Accounting ratios such as EBITDA, debt to equity and others are likely to be impacted. This will have follow on consequences impacting including lender covenants and thresholds for regulated incentivisation schemes; and
- Regulatory thresholds may be breached so that exemptions may no longer be available, for example the audit exemption.
The tax
- The gross asset calculation is used to determine the eligibility of companies for tax-advantageous schemes such as SEIS and EIS as well as any of tax-advantaged share option schemes. To the extent that bringing right of use assets onto the balance sheet adjusts the gross asset calculation, businesses need to be aware of this and consider if it impacts them and how to respond.
- Adjustments to the gross asset calculation will also impact small to medium-sized company status when considering other tax rules such as transfer pricing and the off-payroll rules.
- If any of the financial metrics that have been used in creating performance targets for incentivisation schemes change, then amending the performance target should be considered.
- For the purposes of the corporate interest restriction (CIR), interest charges arising in relation to operating leases are excluded from the CIR calculation. That is not the case for what would have been a finance lease and so businesses must be aware of the need to continue to track interest charges in relation to these leases.
Revenue recognition accounting requirements
The changes coming into effect on 1 January 2026 implement a 5-step model for the recognition of revenue derived from customer contracts, according to the supply made under the contract and the amount of the consideration received. The 5 steps are:
- Step 1: Identify the contract with a customer
- Step 2: Identify the performance obligations in the contract
- Step 3: Determine the transaction price
- Step 4: Allocate the transaction price to the performance obligations in the contract
- Step 5: Recognise revenue when (or as) the company satisfies a performance obligation
Effectively, revenue will now be recognised in accordance with when the supplier expects to be entitled to the consideration it receives in return for the supply under the contract. As a result revenue must be allocated to the supply under the contract as well as any performance conditions and is recognised as and when the supply is made or a performance condition is met. For example (and simplistically) if a piece of kit is sold under contract together with obligation to support that kit for a period of time, a portion of the consideration must be allocated to that performance condition and recognised only as and when the performance condition is met.
Although these changes bring FRS 102 (and 105) in line with IFRS, these changes will be wholly new to businesses not using IFRS up to now. It will also change when revenue is recognised and may impact revenue figures in a particular year. From 1 January 2026, businesses need to analyse their contracts carefully to ensure compliance.
Helpfully, the FRC have issued a series of factsheets intended to assist businesses with the transition to FRS 102. See here FRC issues updated suite of factsheets for FRS 102
Amidst all the other change businesses need to be dealing with this year, here is another which does need attention to be ready for 1 January 2026.