The lease accounting rules for many businesses leasing assets will change starting January 2026. These changes bring FRS 102 in line with IFRS 16, which introduced similar lease accounting rules for listed companies back in 2019. Businesses should also consider the potential tax implications, as the new approach can affect the timing of deductions and reported profits.
Companies should not only prepare for the financial impact but also plan for the broader effects these changes may have on their operations. The amendments to FRS 102 are effective for accounting periods beginning on or after 1 January 2026, except for supplier finance disclosures which are required from 1 January 2025.
New accounting standards are changing how leases are reported in financial statements. Lessees will now need to recognise lease liabilities on their balance sheets, representing their commitment to future rental payments. At the same time, a corresponding right-of-use (ROU) asset will be recorded, reflecting the exclusive use of the leased asset over the term of the lease. The previous distinction between finance and operating leases will no longer apply — all leases will now be recognised on balance sheet, except for certain exemptions such as short-term leases (under 12 months) and low-value assets (like laptops or mobile phones).
This change means that the previous distinction between operating leases and finance leases no longer applies for lessees. Instead of recognising operating lease expenses as rentals, companies will account for depreciation on the ROU asset and interest on the lease liability.
Lease liabilities are measured at the present value of future lease payments, discounted using specified interest rates. The ROU asset is initially calculated by adding the lease liability to certain additional costs.
While the total cost recognised over the life of the lease remains the same, the timing of expenses changes — depreciation and interest costs will typically be higher in the early years and lower later on.
While these changes have been in effect for publicly listed companies and some public sector bodies since 2019 under IFRS 16, similar rules will soon apply to UK limited companies following Financial Reporting Standard 102 (New FRS 102). Starting from accounting periods beginning on or after 1st January 2026, UK companies will need to apply these standards, eliminating the traditional operating vs finance lease distinction for financial reporting purposes.
So, what is changing and why?
Companies will now be required to report future lease payments as a “right of use” asset and a corresponding liability. They must include these fixed assets on their balance sheet.
The "right of use" asset is valued by taking the remaining lease payments and discounting them using either the lease’s implicit interest rate or the company’s cost of capital. This asset is then depreciated over the remaining lease period. Interest expense is recorded in the profit and loss account based on the outstanding lease liability, which decreases as lease payments are made.
So why is this change happening? The main reason for this change to make financial statements much more transparent for investors and stakeholders. This move is designed to make financial statements clearer and more comparable, giving investors and stakeholders a better view of a company’s total borrowing and leasing commitments.
It will be simpler to see the company’s total borrowings directly, without needing to dig through the account notes. This helps investors and partners better understand the company’s overall financial position.
What does this mean for you?
Even though this change doesn’t come into effect until January 1st, 2026, it is important for businesses to start preparing now. Early preparation will help you better manage the transition and fully understand how the changes will impact your operations.
The earlier you begin to understand the potential impact of the new standard may have on your entity, the better prepared you will be to resolve any potential issues, reduce implementation costs and comply with new regulations.
Things to Consider:
- Does the finance team have the required knowledge of the new lease accounting requirements, or do they need further training?
- Do you have copies of all your lease agreements, and do they reflect the key terms used in the financial statement amounts?
- What type of leases does the entity have?
How Lease Changes Affect Your Financial Reports
If your business uses operating leases, you’ll report higher assets and liabilities on the balance sheet. This can increase your gearing ratios. However, EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation) may also rise, as it does not include depreciation or interest expenses.
These changes will typically have a greater impact on property leases, which tend to be higher in value and longer in term. In contrast, motor vehicle leases are usually lower in value and shorter in duration, resulting in a smaller impact.
Because operating leases will now appear on the balance sheet, total assets will increase, which will potentially affect a company’s eligibility for certain tax reliefs (such as EIS, SEIS, or SME exemptions).
There may also be deferred tax considerations where accounting and tax timings differ, and companies subject to corporate interest restriction rules may need to adjust for increased finance costs.
What You’ll Need: Data, Systems & Calculations
You’ll need to gather detailed information about future lease payments for all operating leases with more than 12 months remaining. For each lease, you must calculate the “right-of-use” asset and the corresponding liability.
You'll also need to determine whether to discount future rental payments using:
- The implicit interest rate in the lease, or
- Your own cost of capital.
As part of the transition, businesses won’t restate prior-year figures. Instead, any adjustment when adopting the new rules will be recorded in opening retained earnings, spread across the average lease term for tax purposes.
Partnerships should be aware that changes in timing could alter when partners need to pay tax — potentially leading to higher payments earlier than expected.
If the valuation difference is material, it's important to agree on the appropriate discount rate with your auditors.
Whenever leases are rewritten, due to changes in terms, mileage, or other factors, you will need to revise the calculations for both the asset and liability.
In terms of tracking accounting entries, while proprietary lease accounting systems are available, many businesses rely on spreadsheets. If that’s your approach, close collaboration with lease providers is essential to ensure data accuracy and to keep the process manageable.
Making Smarter Funding Decisions Under the New Rules
Due to the administrative and accounting complexities, you might consider moving away from operating lease arrangements. However, by working closely with your lease providers, these complexities can be minimised, and several key benefits may still make leasing attractive:
- Private equity-backed companies that use EBITDA as a performance measure can now adopt operating leases without impacting reported results. This offers an alternative source of funding beyond bank loans or working capital.
- Businesses transitioning to electric commercial vehicles can consider contract hire, knowing that the lease provider assumes the disposal value risk.
- Electric company car policies can deliver significant cost savings for both employers and employees, particularly when structured using a Whole Life Cost model. Contract hire supports this methodology effectively, especially when incorporating driver contributions.
Although these changes will increase administrative requirements, early preparation will help businesses manage the transition smoothly. Ensuring lease data is complete and systems are ready will reduce compliance risks and make future reporting more efficient.
Need Help?
At FleetSauce, we are always happy to assist businesses when it comes to their vehicles and fleets. We do our best to help in any way we can. If you have any issues or queries, we're happy to see what we can do to assist.
This article is for informational purposes only and should not be taken as professional advice.
