“Most leases that were previously operating leases now move onto the balance sheet.”
Sebastian Suchodolski
FRS 102 Section 20: What changes and why it matters
The amended FRS 102 brings operating leases onto the balance sheet for the first time. Here is what UK and Ireland SMEs need to know about the scope, the impact on the numbers, and the December 2026 deadline.
Part 1 of 3. This is the first in a three-part series on the amended FRS 102 Section 20. Part 2 covers the step-by-step transition guide. Part 3 describes what a well-run FRS 102 lease process looks like.
If your company reports under FRS 102 and has leases for offices, vehicles, equipment, IT hardware or other business assets, the accounting is changing.
The revised lease accounting requirements in FRS 102 Section 20 apply for accounting periods beginning on or after 1 January 2026. For companies with a 31 December year end, that makes 31 December 2026 the first mandatory reporting date affected by the new model.
The change is significant. Most leases that were previously treated as operating leases will now be recognised on the balance sheet. Instead of a single lease expense passing through the profit and loss account, the lessee recognises a right-of-use asset and a corresponding lease liability.
That affects more than the accounting entries. Total assets increase. Liabilities increase. EBITDA may change. Net debt and gearing may change. Covenant calculations may need to be revisited. Audit evidence will also need to be stronger, because lease accounting becomes a balance sheet exercise rather than a note disclosure exercise.
Here is what UK SME finance teams need to know.
What is changing
Under the previous FRS 102 model, operating leases were generally expensed on a straight-line basis over the lease term. The lease did not appear as an asset and liability on the balance sheet. Instead, future lease commitments were disclosed in the notes.
The revised Section 20 moves lessee accounting closer to the IFRS 16 approach. The FRC describes the revised Section 20 as an on-balance-sheet lease accounting model, based on IFRS 16 but with simplifications and modifications for FRS 102 preparers.
In practice, lessees will usually need to:
- recognise a right-of-use asset for the right to use the leased asset
- recognise a lease liability for future lease payments
- depreciate the right-of-use asset over the lease term
- unwind interest on the lease liability using an appropriate discount rate
- present lease costs differently, with depreciation and interest replacing the single operating lease expense line
The total cost over the lease term does not change simply because the accounting model changes. What changes is the timing and presentation of that cost.
For many SMEs, the most visible effect will be that operating lease rental expenses move out of operating expenses and are replaced by depreciation and finance costs. EBITDA often increases, while lease liabilities increase at the same time. Where lease liabilities are included in debt measures, net debt and gearing may also increase.
Who is affected
The changes affect UK and Irish entities reporting under FRS 102 that have leases as a lessee. In practical terms, this includes many SMEs, LLPs, charities and other entities with:
- office or warehouse leases
- vehicle leases
- plant and machinery leases
- IT and office equipment leases
- embedded leases within wider service contracts
There are exemptions, but they need to be applied carefully.
Short-term leases may remain off balance sheet where the lease term is 12 months or less and the relevant exemption is applied. There is also an exemption for leases of low-value underlying assets. However, the low-value assessment is based on the value and nature of the underlying asset, not the size of the monthly payment.
That distinction matters. Revised FRS 102 gives examples of assets that would not be considered low value, including cars, vans, trucks, forklifts, land and buildings, aircraft, railway rolling stock and production line equipment. That means many common SME leases still come into scope, even where the monthly payment is not large. A low-cost van, forklift or small office lease is not automatically a low-value lease for FRS 102 purposes.
The practical message is simple: do not screen leases only by monthly rent. Start with the contract and the underlying asset, then decide whether an exemption is available.
What this means for your numbers
The balance sheet impact can be immediate and material.
| Metric | Before revised Section 20 | After revised Section 20 |
|---|---|---|
| Total assets | No operating lease asset | Right-of-use asset recognised |
| Total liabilities | No operating lease liability | Lease liability recognised |
| EBITDA | Reduced by operating lease expense | Often increases, because depreciation and interest replace lease expense |
| Net debt | Usually excludes operating leases | May include lease liabilities, depending on covenant definitions |
| Gearing | Lower | Often higher |
| Interest cover | No lease interest expense | Lease interest expense recognised |
For companies with bank covenants, the accounting impact should be assessed before the year-end process starts. The issue is not only whether the statutory accounts are correct. It is whether loan agreements, management reporting and lender conversations still work once lease liabilities are included.
A covenant that was comfortable under the old operating lease model may look different once office leases, vehicles and equipment leases are recognised as liabilities.
Where to next
The change is more than a calculation update. It is a process change that affects how the finance team captures lease data, how it documents the discount rate, and how it produces audit evidence.
In Part 2 of this series, we walk through the step-by-step transition guide, from identifying the lease population through to year-end disclosures, with a practical timeline for 31 December 2026 year ends.
Part 3 then covers what a well-run FRS 102 lease process looks like, with the judgement calls explained and how LeaseAccounting.app supports each step.
Continue to Part 2: FRS 102 transition guide.