FRS 102 and IFRS 16: Preparing for the transition

Effective from 1 January 2026 in the UK and Ireland, amendments to FRS 102 will significantly impact lease accounting practices, particularly in how businesses recognize right-of-use (ROU) assets and lease liabilities on their balance sheets.

With FRS 102 becoming more aligned with IFRS 16, companies must adapt their lease accounting processes, particularly in recognizing ROU assets, lease liabilities, and using an appropriate discount rate. Businesses should act now to update internal systems, assess the impact on financial statements, and engage experts to ensure compliance with FRS 102 leases and related reporting requirements.

Below is a practical overview of the reasons for these changes, their implications, differences between FRS 102 and IFRS, recommended actions, and tools that can facilitate a smoother and more accurate transition.

Why are these changes being introduced?

FRS 102 applies primarily to medium-sized and large entities, requiring them to apply the standard when preparing financial statements. Small entities may also apply FRS 102 Section 1A (also referred to as Section 1A of FRS 102) or opt for FRS 105 if they qualify as micro-entities. However, FRS 102 1A offers simplified disclosure requirements.

The primary objective of revising FRS 102 is to harmonize UK GAAP with international frameworks, aligning particularly with IFRS 16 for lease accounting and IFRS 15 for FRS 102 revenue recognition. This alignment enhances the comparability of financial statements globally and provides a more accurate representation of an entity’s assets, liabilities, and income.

The amendments introduce increased transparency. Stakeholders such as lenders and investors require comprehensive information about future lease payment obligations. Aligning FRS 102 leases with IFRS improves the visibility of a company’s financial position by recognizing lease liabilities and ROU assets in the balance sheet.

What do the changes entail?

A significant update in FRS 102 leases is the removal of the distinction between finance leases and operating leases for lessees, with certain practical exceptions. Under the new standard, most leases will be recognized on the balance sheet through:

• Right-of-use (ROU) asset: Accounted for as a non-current asset, measured at the present value of future lease payments, plus any direct costs incurred to establish the lease.
  
  
• Lease liability: It is recognized as a liability corresponding to the lease payment obligation and divided into current and non-current portions.

Similar to IFRS 16, exemptions exist for short-term leases (those with a term of 12 months or less) and leases of low-value assets. These can often continue to be accounted for off-balance sheet, simplifying the reporting process. 

The income statement presentation will also change:

• Depreciation: Applied to the ROU asset.
  
  
• Interest Expense: Recognized on the lease liability.
  
  

For many companies, this will result in a higher EBITDA, as lease expenses move from operating costs to depreciation and finance costs. 

While this article focuses on lease accounting, it’s important to note that FRS 102 also introduces updates to FRS 102 revenue recognition (aligned with IFRS 15), FRS 102 investment property valuation, and other financial reporting aspects.

How does FRS 102 differ from IFRS 16?

While FRS 102's lease accounting requirements are largely aligned with IFRS 16, there are notable differences:

• Discount rate: IFRS 16 requires lessees to use the implicit interest rate if readily determinable; otherwise, they must apply their incremental borrowing rate. FRS 102, however, allows for an obtainable borrowing rate, which may be simpler to determine.
  
  
• Low-value assets: Both standards provide exemptions for low-value assets, but the thresholds and definitions may vary.
  
  
• FRS 102 includes certain simplifications and practical expedients to make the standard more proportionate for private entities, differing from IFRS vs UK GAAP approaches.

How should companies prepare for the changes?

To ensure a smooth transition to the updated FRS 102, consider these steps:

• Inventory all lease contracts: Create a centralized register of lease agreements, detailing lease liability, payment schedules, exemptions, and lease options.
• Evaluate early adoption: Assess whether implementing the changes before 2026 benefits financial reporting.
• Analyze financial impact: Update projections for lease expenses, EBITDA, balance sheet figures, and taxation. Adjust loan agreements and bonus structures if necessary.
• Upgrade systems and procedures: Ensure your accounting software can manage new lease accounting rules, including depreciation and interest on lease liabilities.
• Engage key resources: Consult internal finance teams and external advisors (auditors, consultants, lenders) to support a seamless implementation.

Complying with FRS 102 offers benefits beyond compliance—it enhances contract and vendor management, reduces risk, and improves cost control.

What tools can enhance efficiency and accuracy?

To support FRS 102 compliance, businesses should consider:

• Accounting and ERP systems with lease modules: Some modern accounting systems now include lease modules that automatically calculate the capitalization of leases, including ROU asset depreciation and discount rate calculations.
• Specialized lease accounting solutions: For businesses managing 15+ leases, dedicated contract management software provides oversight of lease liability, payment schedules, and automated alerts.
• Cloud-based lease calculators: Useful for smaller businesses, these tools assist in computing present values, depreciation, and interest.

Given that FRS 102 and lease agreements encompass more than mere compliance, considering specialized solutions for these tasks can be highly beneficial. If your organization manages more than 15 lease agreements, investing in dedicated contract management systems may be prudent. These systems provide comprehensive oversight of due dates, amendment clauses, and automated reminders.

Digital contract management solutions, including specialized IFRS 16 tools developed by House of Control, offer additional advantages. With centralized oversight and management of all agreements, both procurement and finance departments can view the company's contracts and obligations holistically.

Such solutions also enable colleagues handling contracts and vendors, who may not use the ERP system, to indirectly contribute to efficient and accurate reporting of lease contracts.

We have partnered with consultants to assist our clients in maximizing the value of our software. These consultants also support clients in achieving better compliance, improved contract and vendor management, and significant cost reductions.