FRS 102 Lease Accounting Changes: a Guide for SMEs (2026 Update)

Revisions to FRS 102 may at first glance appear to be small, but they can have a big impact for businesses, especially those reliant on leasing. Discover what’s changing, the new reporting rules businesses need to follow, and how this impacts your EBITDA with our guide.

What are the new lease accounting rules from FRS 102?  

Previously, there was a distinction between finance leases and operating leases:

• Finance leases: Where the lessee bears the risks and rewards of ownership of an asset. A finance lease would appear as an asset and a liability (similar to a loan) on a company’s balance sheet.
• Operating leases: A lessee does not bear the majority of the risks or rewards associated with ownership. In contrast, operating leases were accounted for off-balance sheet. These appeared as income statement expenses over time.

From 1 January 2026, this clear distinction between finance and operating leases no longer applies. Instead, all leases will face similar treatment to the way finance leases are handled currently.

A lessee must identify all leases on its balance sheet as a ‘right-of-use’ (ROU) asset with a corresponding lease liability.

When do these come into effect? 

The updated lease accounting rules for FRS 102 will come into effect from 1 January 2026; so this means for years ending 31 December 2026 and beyond. According to the Financial Reporting Council, the changes will impact approximately 3.4 million businesses, with the retail sector in particular expected to be heavily hit.

What are the key features of FRS 102 Lease Accounting I should be aware of as a lessee? 

For many businesses, the changes to FRS 102 won’t change their economic obligations. However, their financial statements will see an increase in assets and liabilities on their company balance sheet.

Where rental costs were previously treated as an expense in profit and loss statements, these will now appear as a depreciation charge for the right-to-use asset as well as finance costs.

Given these depreciation and finance costs are added back when calculating EBITDA, businesses should expect to see their reported EBITDA increase.

Here is a more detailed guide on the changes, and what you should know:

Lessee recognition: Right-of-Use (ROU) asset and lease liability 

Lessees must recognise ROU assets and lease liabilities for most leases. It should appear on your company’s balance sheet as a fixed asset from the start of the lease. The ROU assets will be determined from the initial lease liability amount.

All ROU assets will have a corresponding lease liability. This will be shown as a new liability and be calculated as the present value of future lease payments. Each rent payment will reduce the liability.

These changes will mean higher expenses for businesses at first, when the liability is greater. As the liability reduces, companies will see expenses reduce in later years as the interest element falls. 

For companies on short-term leases or leasing low-value assets, there are exceptions to the FRS 102 revisions to exclude these.

Exemptions explained 

If your lease term ends within 12 months of its start date (short-term leases) or your lease meets the threshold requirements of a “low-value asset”, then it’s likely you’ll be exempt from the FRS 102 revisions. Items like IT equipment typically qualify as a low-value asset, whereas vehicles and property do not.

How to calculate ROU assets and lease liabilities 

All businesses should take the following steps to ensure their financial statements comply with the FRS 102 revised requirements:

1. Compile the remaining lease payments

2. Apply an incremental or obtainable borrowing rate

3. Calculate the present value of the future lease payments at the transition date 

4. ROU assets are depreciated; liabilities incur interest cost via the effective interest method

5. Analyse how these changes will impact your balance sheet and overall EBITDA.  

Transition method for lease accounting

To help businesses adjust to the new requirements, companies won’t need to make a prior year restatement of their accounts for these lease accounting changes

Instead, the lease liability is calculated at the present value of remaining lease payments at the start of the current accounting period. An ROU asset equal to the lease liability is recognised at that date, adjusted for any previously recognised prepayments or accruals.

Example of lease accounting changes 

How will this impact my Financial Statements and KPIs? 

As mentioned previously, the FRS 102 revisions will most impact a business’s balance sheet, profit and loss account and EBITDA. The chart below provides more context:  

Businesses should engage with lenders early to renegotiate covenant terms. 

How do the changes affect lessors?  

For lessors, the FRS 102 revisions bring minimal change. Leases can still be classified as finance or operating.

How will these changes impact my cash flow planning?  

The FRS 102 revisions will split lease payments between principal repayments and interest. This, combined with the changes on balance sheets and P&L reports, will change how operating and financing cash flows appear in cash flow statements. However, there is no change in overall cash outflows. 

Depreciation and interest remain tax deductible but changes in expense timing may affect tax cash flow planning.  

6-step preparation checklist for FRS 102 revised lease accounting changes 

1. Compile a comprehensive lease register (including any embedded leases)

2. Identify contracts under Section 20 FRS 102 Revised (do they contain leases?)  

3. Select discount rate: incremental or obtainable borrowing rate 

4. Calculate transition balances at the start of the accounting period commencing on or after 1 January 2026.  

5. Model financial impact on covenants, reporting and EBITDA  

6. Adjust systems controls, update policies, train staff and involve auditors and legal teams (if necessary) 

FRS 102 and revenue recognition

The FRS 102 revisions will also potentially change how companies recognise and assess revenue.

Out of the various metrics to measure a business’s performance, revenue is vital. The old FRS 102 approach used a “risk and rewards” model, while the revisions embrace a 5-step approach that identifies performance obligations.

With the FRS 102 revisions, revenue will now be recognised when the agreed performance obligations are met. Micro entities are included in the new model as well as all entities entering into contracts with customers.

This approach aligns FRS 102 more closely with IFRS 15 and aims to boost comparability and compatibility.

Tips for updating your revenue recognition methodology for FRS 102

Business should also take into consideration the following in connection with revenue recognition:

1. Review all contracts with bundled goods or services and assign revenue based on standalone selling prices.

2. If you have any agreements with variable payments according to performance or contingent fees, these will require new estimates.

3. Update any disclosures as required. Pay attention to include partitioning of revenue, contract balances and performance obligations.

4. For retailers, ensure your accounting incorporates the FRS 102 revisions for refund liabilities and assets, especially for returns, warranties and loyalty schemes.

5. For these changes to revenue recognition, then you are required to amend the comparative figures in the financial statements. There is a choice to be made in terms of how you present this restatement. 

Get ahead of GAAP lease accounting changes 

FRS 102 revisions may seem minimal, but they can have a big impact on businesses, especially if you’re substantially reliant on leases to manage your operations. Shorts’ Accountancy Services team can examine your financial reporting and leasing requirements and ensure you’re compliant with the latest legislation.