Changes in accounting standards for leases

Changes in accounting standards for leases

FRS 102 is set to be updated to reflect the provisions of IFRS 16 with regard to the accounting for leases. The implementation of these changes will come into effect for the period starting on or after 1 January 2026, the comparatives for the period starting on or after 1 January 2025 should also be considered. Early adoption of these changes is permitted.

The main changes centre around operating leases, where going forward, a large proportion of operating leases will be treated as finance leases, and a ‘right of use’ asset will be created in the balance sheet.

On transition, the remaining value of the operating lease repayments will be capitalised as a ‘right of use’ asset and lease liability in the balance sheet. What was previously treated as operating lease payments will now be split into capital and interest elements and used to reduce the lease liability in the balance sheet and provide an interest charge in the profit and loss account.

The ’right of use’ asset will be depreciated over the life of the lease.

There are exemptions to having to capitalise operating leases as follows:

• Leases that run for less than 12 months.
• Low value leases (overall value of less than €5,000 in IFRS 16, but no figure has been mentioned in FRS 102).

Leases that meet the above exemptions can still be treated as operating leases.

Service contracts do not need to be capitalised. A service contract exists if any of the following situations exist:

• There is no identifiable asset.
• The supplier has the right to substitute the asset.
• The customer does not control the use of the asset.
• The customer does not substantially obtain all economic benefits from using the asset.

Areas to consider when dealing with the new lease accounting standards under FRS 102

• The increase asset value may impact on audit exemption thresholds
• Stakeholders get a more transparent view of liabilities and financial commitments of the reporting entity.
• There is significant additional time and resources for transitioning and future reporting under the new standard.
• New systems may be required.
• An appropriate interest rate should be used to calculate the present value of future lease payment over the life of the lease.
• Additional staff training may be needed as there is more complexity in the accounting.
• The reporting entity’s accounting ratio’s such as debt to equity, EBITDA, return on assets employed etc, may be impacted. This should be discussed with lenders where it impacts on lending facility covenants.

Conclusion

The implementation of the new accounting standards for lease accounting provides more accurate financial representation and transparency, benefitting investors and stakeholders. However, the transition can be resource-intensive, with notable impacts on financial ratios and administrative complexity. Companies need to weigh these factors carefully and plan for a smooth implementation process.

Please do not hesitate to contact us if you wish to discuss the implications in more detail.