Changes to FRS102: Operating Leases

In March 2024, the Financial Reporting Council (FRC) concluded its second periodic review of the Financial Reporting Standard (FRS102) and issued amendments to FRS102. Whilst the revisions will apply to financial periods beginning on or after 1 January 2026, early adoption is advised. There is time to prepare, however, the impact could be significant for many businesses and an initial assessment of the implications should be done sooner rather than later.

The changes move the accounting to a basis more aligned to international accounting standards. John Perry, Audit Partner explores one of the key accounting areas that will see change: operating leases.

The manufacturing and engineering sector, in particular, is typically an asset heavy sector – the acquisition of such assets will be from excess cash or finance – typically a loan or lease.  Depending on the nature of the lease this will either be recognised on the balance sheet (a finance lease or HP) or expensed through the profit and loss account (an operating lease).  The new approach follows that of IFRS 16; Leases, and more leases will be recognised on balance sheet as the distinction between operating and finance leases has been removed.

In respect of those leases previously recognised as an operating lease, the standard brings in a liability reflecting the obligation to make payments over the lease term and an associated right of use asset. The lease liability is discounted to reflect the time value of money with the rate of discount being based on the interest rate implicit in the lease. If this cannot be determined, the lessee can choose to apply their incremental borrowing rate or their obtainable borrowing rate. The income statement will see charges relating to the depreciation of the right of use asset and the interest element of payments.

There are exemptions available, but these are limited to short terms leases (12 months or less) and leases of low value assets. All other assets will be recognised in line with the revised standard and will include assets such as property, machinery, cars, fleet, etc.

As profits and net debt could be impacted by the new requirements an early assessment of the implications is key to allow proper planning and communication on matters such as:

• Finance team readiness and the need for appropriate training to ensure that the new requirements are fully understood, not just the accounting but also the financial statement disclosure requirements.
• Systems to ensure these can deal with the incoming changes, if nothing else it is likely that the existing chart of accounts would need to be updated and reviewed.
• Covenants and the impact of changes to profits and net debt on the current headroom.
• The timing and amount of corporation tax payments.
• Remuneration strategies and whether revisions may be required to arrangements linked to financial performance (performance related pay, bonuses or share options).
• Corporate transactions and what the impact could be on earn out agreements.

The implementation date may feel like it is some way off, however, the impacts need to be understood to enable appropriate implementation plans to be put in place and to ensure that the expectations of stakeholders are appropriately managed.

If you would like to discuss how these changes may affect you, and what you need to do to prepare, do get in touch today to find out more. Email John Perry at hello@scruttonbland.co.uk or call 0330 058 6559.