As we discussed in last week’s blog, the Financial Reporting Council announced some important changes to FRS 102 in March 2024.
These changes are effective for accounting periods commencing 1 January 2026, with early adoption allowed. There were no lease accounting changes to FRS 105, but this article focuses on FRS 102. See last week’s blog for the Revenue Recognition changes to FRS 102.
Lease Accounting Changes
IFRS 16 first introduced an on-balance sheet model for lessees five years ago in 2019. FRS 102 is doing something similar now. Essentially, it means that companies will need to recognise a lease liability on the balance sheet and a corresponding right of use asset for those operating lease commitments that are currently expensed to the profit or loss.
The lease liability will be calculated using the present value of the company’s payment obligations over the remaining lease term based on a bank quotation for an interest rate for a right of use asset for the same amount.
There are recognition exemptions available for ‘low value’ or ‘short leases’ as well.
Implications of these changes
- Balance sheet – there will be an increase in total assets and total liabilities.
- Income statement – we are going to see amortisation charges for leases increase over the life of the lease unless the company is already measuring the respective asset categories on a ‘fair value basis’ where they will continue to do so using the effective interest rate.
- Operating lease expenses currently in the profit or loss will be replaced by a combination of depreciation plus finance lease interest expenses which will ultimately lead to an increase in EBITDA.
- Cash flow statement – the cash paid under the lease will remain the same, but the classification in the cash flow statement will lead to:
- An increase in cash flows from operating activities
- An increase in the outflows from financing activities
- Impact on financial ratios especially those linked to EBITDA, gearing, and net debt. Companies may need to examine more closely their:
- Debt covenants;
- Incentives; and
- other obligations that involve these EBITDA measures.
Other Disclosure Changes
Additional disclosures will also be required – both qualitative and quantitative information for lease commitments. Additionally, those companies that avail of the recognition exemption for ‘short term’ or ‘low value’ leases will need to disclose the precise details of the leases involved.
Simplification
There is a useful simplification to do with the use of discount rates. IFRS 16 requires the use of an ‘incremental borrowing rate’ (IBR), and this is where the rate implicit in the lease can’t be determined.
FRS 102 allows for the IBR too, but as an ‘easier’ alternative permits the use of an ‘obtainable borrowing rate’ (OBR) which is a much less complicated alternative. In cases where neither of these are available, FRS 102 allows for a gilt rate, but this is expected to be a rare occurrence.
Comparatives
The standard allows for the modified retrospective approach with regard to comparatives, meaning there is no need to restate comparatives.
Planning Ahead
Companies need to prepare in advance for the advent of the new FRS 102 leasing requirements by taking the following steps:
- Gather data on existing operating lease arrangements;
- Explore the implications of the potential discount rates that could be used;
- Start performing an initial impact assessment;
- Gauge what impact the leasing changes will have on their:
- Financial ratios;
- Primary statements;
- Balance sheet valuations; and
- Tax liabilities, not ignoring deferred tax.
See our webinar entitled ‘The Main Changes in Irish GAAP’ on the latest changes to FRS 102 here.
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