On 27 March 2024, the FRC issued new amendments to FRS 102. One of the main changes is that a new model of lease accounting is now required which substantially aligns FRS 102 with international accounting standards (IFRS 16: Leases).
How was a property lease previously accounted for under FRS 102?
Previously, if a business rented property, it was treated as follows:
- The annual rent due in respect of the financial year was presented in the profit and loss account as an expense.
- No entries were made regarding the lease on the balance sheet (unless a rent incentive or dilapidations provision needed to be recognised).
- A financial commitment note was included within the notes to the financial statements, which detailed the future rent commitment. This was not recognised as a liability.
How will a property lease be recognised following the amendments to FRS 102?
The initial recognition of the lease will be treated as follows:
- A lease liability will be recognised on the balance sheet which recognises the obligation to make total lease payments over the life of the lease.
- The lease liability is calculated as the present value of the future lease payments and will unwind as an interest expense. The lease payments incorporate several elements, such as fixed rent, anticipated rent reviews etc, but exclude variable elements such as turnover rents.
- When lease payments are made, they will reduce the liability.
- An asset will be recognised on the balance sheet in respect of the property which will be equal to the initial lease liability recognised.
- The asset will also include direct costs of entering into the lease, e.g. legal fees and any restoration/dilapidation costs, which are a separate liability on inception.
- Depreciation is charged on the asset over the life of the lease.
Regular reassessment will then be required of the original entries for any changes such as a rent review or changes to the existing lease terms.
Are there any exemptions?
- The new standard allows short-term leases to be exempt from on-balance sheet accounting. A short-term lease is defined as anything less than 12 months – although care should be taken as the intention is also important when considering this.
When will the amendments take effect?
- The effective date for amendments is for accounting periods beginning on or after 1 January 2026.
- The lease liability is recognised on the remaining lease payments when the revised requirements are first applied as though the lease was entered into on the first day of adoption.
- Comparatives are not required to be restated.
- Any profit and loss impact on adoption will be recognised through opening reserves.
Will there be a corporation tax impact?
HMRC have not yet issued any official guidance. However, the tax legislation implemented for the previous IFRS 16 changes is widely expected to apply:
- The basic principles of tax don’t change. Previously, there was a deductible rent expense; going forward, the depreciation on the lease and the interest charge will be allowable expenses.
- From a tax perspective, we will need to understand how the initial value of the lease is calculated, as it may contain disallowable costs such as Stamp Duty. If this is the case this element of the depreciation and interest is disallowed.
- There may be a slight benefit in tax relief being gained sooner, as generally costs are “front-loaded” on leases, so they will be recognised in the profit and loss account sooner than on a cash basis.
How could the changes impact my business?
- You will need to understand how the above accounting changes impact your KPIs:
- Will covenant calculations be impacted?
- Will remuneration agreements be affected?
- Would the inclusion of a significant asset on the balance sheet affect audit thresholds for gross assets?
An early understanding of how your financial information will change will allow you to manage the impact of the above.
To find out more or for help with the impact of any of the above, please get in touch with your contact in BHP’s property team or FRAV for any accounting-specific queries.
