FRS 102 changes: what do the new lease accounting rules mean for small companies?

The Financial Reporting Council’s periodic review of FRS 102 represents one of the most significant sets of changes since the standard was introduced. While the amendments touch many areas of financial reporting, one change in particular will have a material impact on a large proportion of small companies: the revised accounting treatment for leased assets. 

The revised standards apply to companies preparing accounts under FRS 102, including those that adopt the small entities regime in Section 1A. They do not apply to businesses preparing accounts under the FRS 105 (micro-entities) regime, or to unincorporated entities.

The revised FRS 102 lease accounting rules will bring many leases that were once out of sight, onto the balance sheet for the first time – changing reported assets, liabilities and profit profiles, even though the underlying business activity remains the same.

For many owner-managed businesses, leasing is a fundamental part of how they operate – whether that is property, vehicles, equipment or IT infrastructure. The new requirements will bring much of this activity onto the balance sheet for the first time, changing not only reported numbers but also how stakeholders interpret them.

So, what are the lease accounting changes, and what should small companies be thinking about now?

When do the changes apply, and how do they affect comparatives?

The amendments to FRS 102 take effect for accounting periods beginning on or after 1 January 2026, meaning that for most UK small companies, the changes will first be reflected in accounts for the year ending 31 December 2026 or 31 March 2027.

On adoption, companies must apply a modified retrospective approach.

Essentially, this simplifies transition. Companies will recognise the cumulative impact of bringing leases onto the balance sheet at the start of the year of adoption, rather than restating all prior periods.

The comparative figures presented in the first year under the revised standard are therefore not restated, but disclosures must explain the transition and the impact of the change.

How does this differ for companies preparing management accounts?

Companies that produce periodic management accounts for external stakeholders – such as banks, investors or external shareholders – should be considering adoption now.

If management information continues to be prepared on the old basis, there is a real risk that the first set of statutory accounts under the revised FRS 102 will require significant restatement of previously reported figures.

Adopting the new lease accounting treatment within management accounts ahead of the statutory effective date can help:

• avoid disruption,
• improve consistency between management and statutory reporting, and
• ensure that financial information used for decision‑making remains aligned with future reported results.

The challenge is not just applying the new rules – it is explaining sudden movements in financial position that do not reflect a change in the business itself.

A shift in thinking: The end of “off balance sheet” leasing

Under the current FRS 102 framework, leases are classified as either finance leases or operating leases. For many small companies, most leases fall into the operating lease category, meaning that the accounting is relatively simple: lease payments are expensed to profit and loss over the term of the lease, with limited balance sheet impact.

That distinction is being removed.

Under the revised FRS 102, lessees will be required to recognise:

• a right‑of‑use asset, representing the economic benefit of using the leased item; and
• a corresponding lease liability, representing the obligation to make future lease payments.

This approach broadly aligns with IFRS 16, albeit with some simplifications.

The practical consequence is clear: leases that previously sat “off balance sheet” will now be visible in the company’s statement of financial position.

Why this matters for small companies

For many, the impact will be far from cosmetic.

1.Balance sheets will get “bigger” as more leases appear
Many leases that were previously kept off balance sheet will now be recognised as both a right-of-use asset and a lease liability. This increases reported assets and liabilities, particularly for businesses with large property leases.

2.Key ratios will change
Net assets, gearing and other commonly monitored metrics may move overnight, with no change in the underlying economics of the business.

This could affect perceptions of financial strength and, in some cases, interactions with lenders.

3.Profit profiles will change
Instead of a single lease expense, companies will recognise:

• depreciation on the right‑of‑use asset, and
• interest on the lease liability.

This typically results in a higher charge in the earlier years of a lease, altering profit trends over time.

For owner-managed businesses accustomed to relatively stable rental expenses, this change may come as a surprise.

What was once a steady rental cost may become a front-loaded expense profile.

Optional exemptions – but not a free pass

The revised standard does provide some relief, particularly relevant to smaller entities.

There are exemptions for:

• short-term leases (generally those of 12 months or less); and
• low value assets, such as small items of office equipment.

However, these exemptions are unlikely to apply to the most material leases for small companies, such as property or vehicle fleets.

As a result, many businesses that have historically paid little attention to the technical detail of leasing will need to engage with it for the first time.

Practical challenges: data, judgments and systems

While the concept of recognising leases on the balance sheet is straightforward in theory, the practical implementation can be challenging.

Small companies will need to:

• identify all contracts that contain a lease (which may not always be obvious);
• determine lease terms, including renewal and break options;
• calculate appropriate discount rates where these are not explicitly stated; and
• maintain accurate schedules over the life of each lease.

For businesses with multiple leases, particularly those entered into over many years, this represents an additional compliance burden, highlighting the importance of early preparation and good quality underlying records.

The most challenging part is not the calculation. It’s gathering complete and reliable data. Early preparation and good quality underlying records are paramount.

Other FRS 102 changes worth noting

While leases will attract most attention, they are not the only area of reform.

Other notable changes include:

• Revenue recognition, with refinements designed to better reflect performance obligations
• Financial instruments, including clarifications around measurement and impairment
• Business combinations and group accounting, with targeted improvements
• Disclosure requirements, which in some areas increase the explanatory narrative expected in the accounts (including changes to related party disclosures)

Individually, some of these changes may feel incremental. Taken together, they reinforce the direction of travel towards more robust and transparent financial reporting across UK GAAP, even for smaller entities.

What should businesses be doing now?

The key message for small companies is not to wait. Lease accounting under FRS 102 will no longer be a purely technical, year-end exercise.

Businesses should now:

• identify affected leases
• understand the likely balance sheet and profit impact
• consider how these changes will feed through into both statutory and management reporting
• open a dialogue with stakeholders who may be impacted by these changes (such as shareholders, banks, etc.)

Early modelling and discussion with advisers will help avoid surprises, reduce disruption in the first year of adoption, and ensure that financial information remains consistent, reliable and fit for purpose.

The changes to FRS 102 mark a clear step change in how leasing arrangements are reflected in small company accounts. While the underlying cash flows and commercial realities may be unchanged, the story told by the financial statements will look different. 

How can the Accounting and Business Advisory team at MHA help?

This is not just a year-end exercise – it’s a change that needs to be understood and planned for early, reducing disruption and avoiding those difficult conversations later. For many small companies, lease accounting will be the most visible and potentially most misunderstood change under FRS 102.

At MHA, we can help you identify which contracts are in scope, model the balance sheet and profit impact, and support you through the transition so that your statutory accounts and management information remain consistent and compliant.

We can also help you plan and communicate the change clearly to banks, investors, shareholders and other stakeholders, so that an accounting change does not create unnecessary concern or commercial friction.

Colin Johnson is a Partner with MHA, one of the UK’s leading accountancy firms with offices in Edinburgh and Aberdeen. MHA is the independent UK member firm of Baker Tilly International.

For more information visit www.mha.co.uk