8 01732 759725 For years, many UK businesses have enjoyed the relative simplicity of ‘off-balance sheet’ accounting for their operating leases. A straightforward rent expense would hit the profit and loss account, and for a multitude of entities that was largely the extent of it. However, a significant change is on the horizon for UK Generally Accepted Accounting Practice (UK GAAP) under the new Financial Reporting Standards (FRS) 102, which brings it much closer to the international standard, International Financial Reporting Standards (IFRS) 16 Leases. This isn’t just a minor tweak; it’s a fundamental overhaul that will transform how many businesses present their financial position. The good news is you have some time to prepare, but don’t put it off as these changes will shake up balance sheets across the mid-market. From January 2026, the new FRS 102 introduces a ‘right-of-use’ (ROU) model for lessees, largely mirroring IFRS 16. This means that for virtually all leases, the distinction between finance and operating leases for lessees is removed. Instead, businesses will be required to recognise: A Right-of-Use (ROU) Asset: This asset represents the lessee’s right to use the leased item over the lease term. It will appear on the balance sheet, typically alongside property, plant and equipment. A lease liability: This liability represents the obligation to make lease payments over the lease term. It will also be recognised on the balance sheet, divided into current and noncurrent portions. What does this mean for financial statements? The impact of this change will be significant for many businesses, particularly those with a substantial portfolio of operating leases. Retailers with multiple leases, manufacturers leasing machinery, and logistics firms with rolling fleet contracts will be among those most affected. This is what you need to know: You can expect your balance sheet to grow, with an increase in both assets (ROU assets) and liabilities (lease liabilities). This will alter key financial ratios, such as leverage and debt-to-equity. The familiar ‘rent expense’ will largely disappear from your profit and loss. Instead, your profit and loss account will show: n Depreciation of the ROU asset. n Interest expense on the lease liability. This will often result in a higher EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortisation) as lease costs shift from operating expenses to depreciation and finance costs. Businesses with loan agreements tied to financial covenants (e.g. debt-to-EBITDA ratios, interest cover) will need to carefully assess the potential impact of these changes. Start having discussions with lenders now. The increase in reported assets could push some businesses over thresholds for company size, potentially impacting audit requirements or simplified reporting options. Identifying all lease contracts, including those ‘hidden’ within service agreements, will be crucial. Accurate calculation of the ROU asset and lease liability requires detailed information on lease terms, payment schedules, extension options and an appropriate discount rate. What should finance leaders be doing now? These changes will significantly affect how leases are reported, and early preparation will help finance leaders avoid any lastminute scrambles. Start by reviewing all contracts to identify current leases, including those embedded within broader service agreements that may have previously flown under the radar. For each lease, finance teams should gather full details such as term length, payment structure, extension options and any related costs. Modelling the likely impact on key financial statements and ratios, particularly debt levels and EBITDA, will be an essential step of any preparation. Businesses with loan covenants tied to these metrics should begin conversations with lenders to pre‑empt any challenges. Equally important is reviewing whether existing finance systems can handle the new requirements. For businesses with large or complex lease portfolios, dedicated lease accounting tools may now be a necessity rather than a nice-to-have. Finally, consult with auditors or advisors to ensure your transition plan is robust. A proactive approach now could be the difference between a smooth adjustment and a compliance headache down the line. The shift in UK GAAP lease accounting is a significant one, promising greater transparency but also demanding careful preparation. By understanding the changes and planning proactively, businesses can navigate this new landscape effectively and ensure compliance by the effective date. www.cpio.co.ukw Andrew Watkinson, Managing Director of long-standing Sage partner CPiO, outlines the impact changes to UK GAAP lease accounting could have on the EBITDA, loan covenants and audit thresholds of UK businesses with operating leases How to prepare for the UK’s new lease accounting rules LEASING Andrew Watkinson
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