Businesses will soon be required to capitalise operating leases as a ‘right of use’ asset following a significant change under FRS 102, the Financial Reporting Standard applicable in the UK and the Republic of Ireland.
This is a considerable amendment in accounting treatment for businesses that use assets held under an operating lease agreement.
The changes do not impact companies under the FRS105 micro regime, but small, medium and large businesses need to be aware of what is changing and how to prepare for the transition.
Currently, all operating leases are ‘off balance sheet,’ but for periods commencing on or after January 1 2026, businesses will need to bring operating leased assets onto the balance sheet as a ‘right of use’ asset with a corresponding lease liability.
Examples include property, motor vehicles or plant and equipment.
There are exemptions for low-value assets, such as small office furniture and mobile phones, and short-life leases of less than 12 months.
To prepare, businesses will need to identify all operating leases, review the lease terms and calculate the remaining payments due on that lease from the first day of the accounting period impacted.
This will form the basis of the lease calculation. Be mindful of optional lease extensions or variations in lease agreements that might impact on the calculation.
Businesses will also need to determine an appropriate discount rate to use when calculating the present value of future operating lease payments.
Other key considerations include the impact on any bank covenants and if the increase in gross assets may breach the audit threshold (relevant if the business or organisation has already breached the revenue or employee metrics).
For a business with a number of operating leases – offices, warehouses, retail spaces, cars and other high-value equipment – there will be some work to do to identify operating leases and prepare to bring them onto the balance sheet, as well as updating systems and processes to comply with the new FRS 102 requirements.
While accounting for new lease changes isn’t mandatory until accounting periods commencing on or after January 1 2026, businesses need to be thinking about it now to ensure they are aware of any impacts, and to determine the implicit interest rate that will be needed to calculate the change on the implementation date.
