Amendments to FRS 102 - Focus on Section 20 Leases

For lessees, the amendments could have a significant impact, as most leases will be brought onto the balance sheet. For lessors, the changes are not expected to be significant. The amendments are intended to enhance transparency and comparability of financial reporting between companies.

Summary of the FRS 102 key changes

The lease accounting requirements have been completely replaced with a new section that is based on IFRS 16 Leases (“IFRS 16”). 

For lessees, the distinction between operating and finance lease arrangements has been removed. A lessee should expect to recognise a new right-of-use asset within fixed assets, which represents the right to use the underlying asset specified in the contract, together with a corresponding lease liability, measured at the present value of the future lease payments. The right-of-use asset is measured initially at the amount of the lease liability adjusted for lease payments made before the start of the lease, any lease incentives received and initial direct costs.

Subsequently, the right-of-use asset will be depreciated over the remaining term of the lease. The lease liability is decreased by the lease payments and increased by the unwinding of the discount (the finance charge).

This means there will be changes to the presentation of the lease expense in the income statement. The current rental expense recognised in relation to operating leases will be replaced with depreciation of the right-of-use asset, together with a finance charge arising from the unwinding of the lease liability. Although over the lease term, the charge to the income statement will remain equal, the timing of this will change, with a higher finance charge at the start of the lease as the lease liability unwinds.

There are exemptions that allow short-term leases (leases of less than 12 months) and leases of low-value assets to remain off-balance sheet. These will continue to be accounted for in a similar way to operating leases under the existing standard.

In addition to the above, the amendments also include enhanced disclosure requirements that are based on IFRS for SMEs.

Compared to IFRS 16, Section 20 includes a number of practical simplifications, which include:

• Discounting using a lessee’s obtainable borrowing rate, as an alternative to the lessee’s incremental borrowing rate, which has proved challenging to calculate for clients applying IFRS 16. The obtainable borrowing rate may be available from the company’s existing lenders;
• Reducing the number of situations where a lease modification requires the determination of a revised discount rate;
• Offering the option of a simpler approach to recognising gains and losses on sale and leaseback transactions; and
• Providing a more permissive approach when determining low-value assets. IFRS 16 provides an indicative figure of $5,000, which is not replicated in Section 20. However, FRS 102 includes examples of assets which would not be of low value, such as land and buildings, vehicles and production line equipment.

Effective date and transition

The amendments are applicable to accounting periods beginning on or after 1 January 2026, with early application permitted, provided all other amendments to FRS 102 are applied at the same time.

An entity must apply a modified retrospective approach on first-time application of the amendments. Under this approach, comparative period information is not restated; instead, a cumulative “catch up” adjustment is recognised in retained earnings at the date of initial application, which for those companies with a 31 December year end would be 1 January 2026.

There are a number of transitional provisions available on first-time application of the new requirements to simplify the transition process; some of which are optional and some are mandatory.

For those companies that “group-report” under IFRS, the provisions permit a lessee to use, at the date of initial application, the carrying amounts of its lease liabilities and right-of-use assets calculated under IFRS 16. This practical expedient is intended to provide efficiencies within groups and minimise measurement differences.

Impact of the FRS 102 changes

The amendments are applicable to all FRS 102 reporters, including those reporting under FRS 102 Section 1A Small Entities.

Almost all entities will be impacted to some extent, although those with a higher number of leases will clearly feel the greatest effect. Industries that saw a significant impact on the adoption of IFRS 16 included:

• Retail;
• Airlines;
• Shipping;
• Professional services;
• Healthcare; and
• Telecoms

For those companies with a large number of leases, early planning for the application of the amendments is essential. All lease contracts will need to be identified, collated and analysed. Management may also consider that the lease portfolio is large enough to warrant the implementation of new software, which will require additional time to implement.

Even for those companies with fewer leases, it is likely the accounting systems and processes will need to be updated to some extent.

Management can expect to see changes to their key performance indicators (“KPIs”) such as leverage ratios, profitability ratios and interest cover ratios, as lease liabilities are brought on to the balance sheet and the operating lease expense is replaced by depreciation and finance charges. This may have practical implications such as impacting the company’s ability to meet existing banking covenants, in which case early conversations with lenders are advised.

For industries heavily reliant on leasing, experience from the application of IFRS 16 illustrates that these changes may be a catalyst for strategic evolution in financial management and decision-making. The application of IFRS 16 saw some companies reevaluate their leasing strategies to mitigate balance sheet impacts, for example, by entering into shorter lease terms or opting for outright purchases of assets.

It is essential that companies understand the impact of Section 20 at an early stage in order to facilitate a smooth transition and to effectively communicate the expected changes with stakeholders.

How our Accounting advisory professionals can help

The Accounting advisory services team has a significant amount of experience advising clients on the adoption of new and revised accounting standards. This includes detailed contract analysis, calculating measurement differences, updating accounting policy manuals and financial statement disclosures, project management support and software vendor selection and implementation support.

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