Last month we reported on a series of changes announced to the Financial Reporting Standard 102 – known as the 2025 Triennial Review. One of the major impacts on many small businesses will be changes to lease accounting. This will directly affect how SMEs accounts are completed for accounting periods commencing on or after 1 January 2026.
What’s Changing?
Many businesses lease buildings or vehicles and a major change is coming in how these leases are presented in the year end accounts. For example, with office rent, the rental payments appear in the profit and loss as an expense as the company is invoiced, but the forthcoming changes will change the presentation so it is more akin to a hire purchase arrangement (known as a right of use asset).
The office (or the vehicle) will be included on the balance sheet as a fixed asset – and a liability for the rentals introduced. The monthly payments will then pay down the liability over the term of the lease, instead of being charged to the profit and loss account, and depreciation will be included in the profit and loss, in their place.
What This Means For You
As a result, future accounts could look quite different to how they are now. Accounts will typically show more assets and liabilities, and in turn, this could affect credit ratings and compliance with debt covenants, as well as changes to reported profits. For some businesses, these changes could also have implications for audit requirements, as the inclusion of more assets and liabilities on the balance sheet may alter thresholds for audit exemption or result in additional audit scrutiny.
For tax purposes, however, there will be no change, as this presentation will be unwound, and tax relief claimed on actual rentals paid.
Balance Sheet Comparison (Before & After FRS 102 Changes)
Below is a simplified example of the difference the incoming changes to FRS102 will have on a balance sheet and income statement.
It illustrates the impact of a 5 year lease of office space at £110,000 rent per annum on the balance sheet at the commencement of the lease, and the income statement after the first year.
The key impacts on the balance sheet:
- The use of the leased office space is now capitalised as an asset on the balance sheet and called a “Right-of-Use asset”
- A lease liability is recognised to reflect the commitment for the remainder of the lease
Income Statement Comparison (Before & After FRS 102 Lease Changes)
Key Impacts on the Income Statement:
- Rent is no longer included
- Instead there is a depreciation charge to reflect the usage over the life of the asset/lease (in this case 5 years)
- There is also an “interest” charge to reflect the lease liability added to the balance sheet. This is done through a mechanism called discounted cashflows which we will assist in calculating.
- You will note in this example EBITDA is higher but net profit is slightly reduced in the revised standards
- Tax doesn’t change
How Can We Help?
We expect in some cases there will be a significant amount of work required to re-present existing leases, and unwind the transactions again for tax purposes, so it will be important to assess the impact on your business at an early stage.
Although the changes taking effect may seem far away at this point, there is likely some work to be done to get your accounts in order, so it’s important to get your head around what’s required, now. It’s also important to take this time to fully understand the full scope of leases and their terms, currently held by your business.
We can help by:
- Talking you through what these changes mean in relation to your businesses, and what actions must be taken.
- Performing a review of your lease agreements to assess the impact on your balance sheet.
- Providing ongoing support to manage the effect of lease accounting changes on financial reporting and debt covenants.
This is one of a series of changes introduced by the 2025 Triennial Review. You can read more about the wider changes introduced, here.
If you would like to discuss any of the changes discussed and what you need to do to bring your accounts in line, reach out to your usual contact at Foxley Kingham. Or, if you would like to arrange a discussion as to how our firm can help your business, we’d love to hear from you. Get in touch.