One of the most significant changes arising from the Financial Reporting Council’s (FRC) periodic review of UK GAAP is the removal of the distinction between operating and finance leases by lessees in FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland. Instead, for accounting periods beginning on or after 1 January 2026 (or earlier if the amendments are adopted early), Section 20 Leases will require lessees to capture most leases on the balance sheet. These changes do not apply to FRS 105 The Financial Reporting Standard applicable to the Micro‑entities Regime. 

Do all leases need to go on the balance sheet?

In short, no. There are two exemptions available that might be relevant; short-term leases (leases with a term of less than 12 months) and leases of low value assets. 

The assessment of whether a lease is of a low value asset is based on the underlying asset, ie, the subject of the lease, rather than the value of the lease payments. Section 20 provides examples of assets that would not be considered low value, including land and buildings, production line equipment and vehicles. Besides this list, judgement will be required. 

The FRS 102 amendments do not refer to a threshold for low value assets; instead, the intention is for FRS 102 to enable a more proportionate approach to recognising leases on-balance sheet.

Where a lease is not exempt on the basis of being either short-term or for a low value asset, it will be necessary to first confirm that the contract contains a lease before then recognising a right-of-use asset and corresponding lease liability. The assets reflect the right to use the asset over the lease term and the liability reflects the obligation to make lease payments.

Measurement of the lease liability and right-of-use asset

The lease liability is initially measured at the present value of the future lease payments unpaid at the commencement date. The lease payments are discounted using the interest rate implicit in the lease or, if that rate cannot be readily determined, either the lessee’s incremental borrowing rate or obtainable borrowing rate.

The right-of-use asset is initially measured at cost, made up of:

• the initial measurement of the lease liability;
• any lease payments made at or before the commencement date;
• less any lease incentives received; 
• any initial direct costs incurred by the lessee; and
• any provision recognised for dismantling or restoring the underlying asset.

Greater transparency

Overall, the new requirements of Section 20 Leases will better reflect the financial impact and commitment of leases on an entity’s financial performance and position. This will provide greater transparency and comparability for the users of financial statements, which will, in turn, facilitate more informed decisions.

Fahad Asgar, Technical Manager, Corporate Reporting Faculty, ICAEW

A longer version of this article is available in By All Accounts, the Corporate Reporting Faculty’s online collection of articles exploring corporate reporting trends.