Big changes are coming to accounting in the UK and Republic of Ireland. The Financial Reporting Council (FRC) has issued the most extensive revisions to FRS 102 since the standard’s initial launch in 2013. The revisions will bring UK GAAP closer to IFRS and include fundamental changes to how leases are accounted for and revenue is recognised. Changes take effect in accounting periods beginning on or after 1 January 2026, so now is the time to get informed and start preparing.
Overhauling to align with global standards
The primary driver behind these amendments is to bring the United Kingdom and Republic of Ireland GAAP more closely in line with International Financial Reporting Standards (IFRS). This is intended to:
- Enhance clarity and consistency in financial reporting.
- Improve comparability with IFRS, benefiting businesses with international operations or those seeking foreign investment.
- Ensure continued relevance of financial reporting in the face of evolving business practices and regulatory expectations.
Lease accounting: Say goodbye to off-balance sheet operating leases
One of the most far-reaching changes is to lease accounting. FRS 102 is adopting an “on-balance sheet” model for lessees that broadly mirrors IFRS 16. Currently, FRS 102 distinguishes between finance leases (already on the balance sheet) and operating leases (typically expensed in the income statement). The amendments will eliminate this distinction for lessees. Key changes include:
- Right-of-Use (ROU) Asset and Lease Liability Recognition: Lessees will recognise a right-of-use asset and a corresponding lease liability for most leases. This will replace the previous rental expense with depreciation of the ROU asset and interest expense on the lease liability in the income statement. Both finance and operating leases will be treated in this way with the only exceptions being for short term or low value leases. This change may impact profit before tax (likely lower) due to the front-loading of interest expenses.
- Expense Recognition Shift: Instead of recognising lease payments as an operating expense, organisations will now account for depreciation on the ROU asset and interest on the lease liability. This change will significantly impact key financial metrics like EBITDA (likely to increase) and net debt (likely to increase).
Organisations with a high volume of operating leases will see a noticeable change on their balance sheet. In the US, where a similar accounting change has already taken place, an estimated $2 to $3 trillion USD in lease liabilities were brought onto the balance sheet in aggregate.
Revenue recognition: A five-step approach
The other major change is in revenue recognition. This update shifts the focus from the transfer of risks and rewards to the transfer of control of goods or services. To do this, FRS 102 will adopt a five-step model that aligns with IFRS 15:
- Identify the contract(s) with a customer.
- Identify the performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price to the performance obligations.
- Recognise revenue when (or as) performance obligations are satisfied.
This more detailed framework requires businesses to more rigorously assess their contracts, particularly those with bundled goods or services, variable consideration, warranties, or significant financing components. For contracts with payment terms extending beyond six months, organisations must also consider the time value of money. This could lead to changes in the timing of revenue recognition, especially for long-term contracts.
What this means for your organisation: Impact and considerations
These changes will have a wide-ranging impact on organisations reporting under UK GAAP, including:
- Financial Metrics: Impacts to key performance indicators like EBITDA, profit, and net debt may necessitate reviewing debt covenants and performance-related remuneration schemes.
- Systems and Processes: Accounting systems and processes will need updates to accommodate the new requirements for lease and revenue accounting.
- Distributable Reserves: The revised income statement profile, particularly with the recognition of depreciation and interest from leases, could impact the ability to pay dividends.
Next steps: Getting ready for 2026
Changes of this scale require preparation. Here are some key steps to take:
- Impact Assessment: Conduct a thorough review of existing accounting policies, lease agreements, and customer contracts to identify the potential impact of the amendments.
- System Review: Assess whether current accounting software and systems can handle the new requirements. Upgrades or new solutions including lease accounting software, like LeaseQuery, or a revenue recognition tool may be necessary. Start reviewing new solutions early to ensure sufficient time for selection and implementation.
- Data Gathering: Start collecting the necessary data for lease accounting, including lease terms, payment schedules, and discount rates. Review customer contracts to understand performance obligations and transaction prices.
- Training: Ensure accounting and finance teams are well-trained on the new accounting standards and their implications.
- Early Engagement: Engage with auditors and business advisors early to discuss the potential impact and ensure a smooth transition.
Conclusion: Prepare now for a smooth transition
The FRS 102 Periodic Review 2024 introduces the most far-reaching changes to the United Kingdom and Republic of Ireland GAAP since its initial implementation. In particular, the alignment of lease accounting with IFRS 16 and revenue recognition with IFRS 15 represents a significant shift in accounting practices. By understanding the reasons behind these changes, being aware of the key amendments to lease accounting and revenue recognition, and by taking proactive steps now, businesses can ensure a smoother transition. Don’t wait until 2026 – the time to prepare is now.
