FRS 102 Lease Accounting Changes 2026: A Practical Transition Guide

What is changing under FRS 102 from 2026?

For lessees, the familiar question “is this an operating lease or a finance lease?” goes away. Almost every lease is now recognised on the balance sheet in the same way: a right-of-use asset representing your right to use the asset, and a lease liability representing the obligation to pay for it.

The profit and loss account changes shape too. Instead of one straight-line rental expense, you book depreciation of the right-of-use asset and interest on the lease liability. Lessor accounting is largely unchanged. This is a lessee story.

Why are most leases going on the balance sheet?

The aim is to show the economic reality: a multi-year lease is a financing arrangement, not just a recurring cost. A single five-year property lease can put a right-of-use asset and a lease liability each worth hundreds of thousands of pounds on a balance sheet that previously showed neither. Across a property and vehicle portfolio, the gross-up is rarely trivial.

Which leases are still exempt?

Two recognition exemptions survive, and they are narrow:

• Short-term leases: a lease term of 12 months or less, with no purchase option.
• Low-value leases: where the underlying asset is of low value when new.

Leases that qualify can stay off balance sheet and be expensed on a systematic basis. For most businesses the bulk of the register, property and vehicles, will not qualify.

How do you transition? Modified retrospective only

This is the point most worth getting right, because it differs from IFRS 16.

IFRS 16 let companies choose between full and modified retrospective transition. The revised FRS 102 does not. There is one route: modified retrospective, and comparatives are not restated. The cumulative effect is recognised as an adjustment to the opening balance of retained earnings at the date of initial application.

The date of initial application is the first day of the first accounting period beginning on or after 1 January 2026. For a December year end that is 1 January 2026. For a 31 March year end it is 1 April 2026.

At that date, for a lease that was previously an operating lease:

• the lease liability is the present value of the remaining lease payments, discounted at the incremental or obtainable borrowing rate at that date;
• the right-of-use asset is set equal to the lease liability, adjusted only for any prepaid or accrued lease payments already on the balance sheet.

Leases already held as finance leases carry over at their existing carrying amounts. Groups already producing IFRS 16 figures for consolidation can elect to bring those carrying amounts across. Other practical expedients include a single discount rate for a portfolio of similar leases, and using hindsight when assessing lease term. Our FRS 102 transition guide covers the mechanics in more detail.

A worked transition example

Take a property lease, originally ten years from 1 January 2021, rent of £100,000 a year paid annually in arrears. The company has a December year end, so the date of initial application is 1 January 2026, and five payments remain. Assume an obtainable borrowing rate of 5 percent and no prepaid or accrued rent.

Step 1, the opening lease liability is the present value of the five remaining payments at 5 percent: £100,000 × 4.3295 = £432,948.

Step 2, the right-of-use asset equals the liability, so it is also £432,948.

Step 3, the first year. Interest is £432,948 at 5 percent, which is £21,647. Depreciation is straight line over the five remaining years, £432,948 divided by 5, which is £86,590. The total charge for 2026 is £108,237, against the old flat rent of £100,000.

That is the headline effect: the total cost over the life of the lease is unchanged, but the charge is front-loaded, higher in the early years and lower later. It is a change in shape, not a change in cash.

How does it affect EBITDA, covenants and thresholds?

• Balance sheet: total assets and total liabilities both rise. Gearing and net-debt measures look worse, even though net assets are broadly unchanged at the outset.
• EBITDA: typically increases, because the rental charge that used to sit above EBITDA is replaced by depreciation and interest, which sit below it. This is a reclassification, not improved cash performance.
• Covenants and KPIs: interest cover, gearing and net-debt covenants can all be affected by the gross-up. Check banking covenants and profit-based targets early, and confirm whether covenants are measured on a frozen-GAAP basis.
• Deferred tax: recognising the asset and liability creates temporary differences, which commonly give rise to deferred tax effects in the early years. The treatment depends on your facts and current tax rules, so take specific advice.

What should finance teams do now?

1. Build a complete lease inventory across property, vehicles, equipment and IT, including leases embedded in service contracts.
2. Confirm which leases fall within the short-term or low-value exemptions.
3. Agree and document the discount-rate approach, lease by lease or by portfolio.
4. Measure the opening right-of-use asset and lease liability per lease at the date of initial application.
5. Model the impact on EBITDA, gearing, interest cover and any covenants, and brief the board.
6. Agree the transition disclosures and the audit evidence trail before year end.

The work is finite. It just has to start sooner than most diaries suggest. For a step-by-step version, see our FRS 102 guide.

Frequently asked questions

This guide is for general information only and does not constitute accounting, audit or legal advice. Seek advice specific to your circumstances before acting.