FRS 102 Lease Accounting Changes in 2026

The Financial Reporting Council (FRC) released the most sweeping FRS 102 updates since the standard was issued in 2013, with mandatory adoption for reporting periods ending on or after 1 January 2026. The reform requires fundamental changes under lease accounting for lessees to recognise almost all leases on their balance sheets. This change eliminates the current distinction between operating leases and finance leases and brings UK and Ireland GAAP closer to international standards, specifically IFRS 16.

For SMEs, property companies, and firms with fleets of vehicles or equipment, this represents the major accounting change in over a decade. Leases that were previously off-balance-sheet will now appear as right-of-use assets and lease liabilities, changing how businesses look financially and affecting key ratios and reporting metrics.

What Are the Current Approaches & Key Changes?

Under current FRS 102 provisions, finance leases are reflected on the balance sheet as both liabilities and assets, and operating leases are off-balance-sheet with rental expense reflected in the income statement. Section 20 of FRS 102 (Third Edition) eliminates the dichotomy, embracing a single model of lease accounting where lessees are required to account for a right-of-use asset together with an associated lease liability on all lease contracts.

The new model calls for initial measurement based on the present value of future lease payments, whose right-of-use asset is the right of the lessee to use the underlying property, equipment, or vehicle during the lease term. The future obligation to pay is expressed in the lease liability, which is calculated using the interest rate implicit in the lease where this is possible or the lessee’s “obtainable borrowing rate” under FRS 102 as the rate at which a lessee would be obligated to borrow an amount equal to the total of the undiscounted lease payments for an equal term.

Two of the exemptions in this context have unproblematic accounting: 12-month or shorter short-term leases that do not contain purchase options, and low-value asset leases. Such frameworks can be left with the traditional expense recognition method, although entities must make clear policy decisions and apply them consistently throughout similar categories of leases.

How Will the FRS 102 Changes Affect the Financial Statements?

Bringing leases onto the balance sheet will reshape how businesses appear financially. Both assets and liabilities increase with right-of-use assets added to the assets and lease obligations added to the liabilities. While this creates a fuller picture of a company’s commitments, it also changes the story that key ratios tell. Many businesses may look more highly leveraged, with equity ratios shifting as assets and liabilities grow together. For management, lenders, and investors, the business may therefore seem more indebted on paper than it did under the old rules, even though nothing has changed operationally.

One of the headline effects is on Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDA). Lease costs no longer appear as a single rental expense; instead, they are split into depreciation of the right-of-use asset and interest on the lease liability. This tends to push EBITDA higher, since the rental charge disappears from operating costs.

The expense profile also changes. Under the current operating lease model, payments are spread evenly across the lease term. Under the new rules, expenses are “front-loaded”: higher in the early years, when interest on the lease liability is greatest, and lower later as the liability unwinds. For companies with long leases, this can mean slimmer profits in year one compared with the old method.

Cash flow presentation will look different, too. Instead of treating all lease payments as operating outflows, the new approach splits them: interest sits in operating activities while capital repayments move to financing activities. The result is a healthier operating cash flow number, even though total cash doesn’t change. This will matter when lenders and investors review covenants and debt capacity.

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What are the Transitional Provisions & Implementation Options?

The FRC has provided some transitional reliefs to reduce the implementation burden. Entities can choose between two approaches:

Full Retrospective Application – In this method, entities can go back and restate the lease accounting of all previous financial periods as if the new lease rules had always applied. It gives a complete historical picture, but it can be time-consuming and complex, especially for businesses with many leases.
Modified Retrospective Application – This method allows the new rules only from the transition date onward. You make a single adjustment to opening equity to account for leases that were previously off-balance sheet. For most SMEs, this approach is likely more practical, as it avoids recalculating historic lease data.

Existing operating leases can also be measured using this simplified method. One common option is to set the right-of-use asset equal to the lease liability (with adjustments for prepaid or accrued lease payments). Companies may also apply a single discount rate at the transition date across all leases, rather than hunting for historic borrowing rates.

Where there are many similar leases, for example, a fleet of vehicles or a chain of shop units, the standard allows a portfolio approach, treating them as one group rather than recalculating each individually. And importantly, leases that expired before the transition date do not need to be revisited.

These reliefs are designed to cut down on complexity without undermining accuracy, but entities still need to make clear policy choices and apply them consistently.

How Should Businesses Prepare for the 2026 FRS 102 Changes?

With the effective date of 1 January 2026 being obligatory for accounting periods commencing on or after that date, entities now have a definite regulatory timeline to work with. The FRC guidance emphasizes that successful implementation requires careful preparation well in advance of the effective date, particularly for entities with complex or multiple lease arrangements.

The accounting requirement of lease accuracy extends far beyond the simple property and equipment leases to leases embedded in service contracts. Managed office services, dedicated manufacturing equipment contracts, and exclusive warehouse facilities all contain lease components that must be carved out and analysed under the new definition of a lease as “a contract that conveys the right to control the use of an identified asset for a period of time in exchange for consideration.”

Data collection must capture all lease terms, payment timetables, renewal and termination alternatives, variable payment terms, and indexation provisions for every lease arrangement discovered. Most organizations discover they have many more lease arrangements than they initially consider, so preparatory inventories are necessary early to comply with regulations.

What Systems & Processes Do I Need to Comply With?

Manual lease accounting is no longer practical for companies with multiple lease contracts. The new rules involve complex calculations for right-of-use asset depreciation, lease liability interest, and remeasurements when leases are modified or reassessed. Most standard accounting software cannot handle these calculations automatically, so many businesses will need specialist lease accounting software or ERP system upgrades.

Training requirements extend beyond technical accounting to address areas of judgment under the new standard. Finance teams must understand lease identification criteria, discount rate determinations, lease modification accounting, and the interface of lease accounting with other sections of FRS 102. The FRC feedback statement that accompanies the standard highlights these judgment areas as being critical to consistent application.

Which Industries are Most Affected by the Lease Accounting Changes?

Some businesses will be impacted more than others. Hotel, retailers, logistics companies, and manufacturers with extensive portfolios of property or vehicle leases will see substantial increases in balance sheet liabilities and assets. This could have an effect on debt covenants, borrowing capacity, and budgeting.

Retail and hospitality businesses with extensive property leases will struggle with debt ratios
Logistics and transport companies will have to cope with hundreds of equipment or vehicle rentals
Manufacturers must distinguish between elements of a lease and service components in embedded leases to get it right in the accounts

Conclusion

The FRS 102 (Third Edition) reforms of lease accounting from 1 January 2026 are mandatory. They require almost all leases to be accounted for on the balance sheet as right-of-use assets and lease liabilities, putting an end to the historic operating vs finance lease distinction.

Compliance relies on thorough preparation: identification of leases, gathering of data, implementation of suitable systems, and training staff. Transitional provisions provide leeway, but reliability and consistency are a prerequisite.

Even after adoption, the changes will define how stakeholders view a company. Credit rating agencies, analysts, and investors are developing how companies are rated, with lease obligations in mind. Pre-adoption can demonstrate proactive compliance and transparency.