For financial periods starting on or after 1 January 2026, lease accounting has undergone its most significant shift in years. What was once hidden in the background has moved front and centre onto your balance sheet and, as we move through the first quarter of the year, millions of UK businesses are seeing the effects of this transition for the first time.
In reality, your business hasn’t changed. You're likely sitting in the same office, your team is driving the same vans, and you are using the same equipment as you did last year. However, under the new FRS 102 rules, the way these assets are recorded on paper now looks very different.
This change isn't just about where the numbers go; it’s about the real impact of making these numbers more visible in your accounts. By bringing leases onto your balance sheet, your 'gross assets' and liabilities will naturally increase. Suddenly, a routine decision, like signing a new office lease, could be the tipping point that pushes your business over the threshold for a mandatory audit or accidentally breaches the terms of your bank loans.
The End of "Off-Balance Sheet" Leasing
Most businesses can no longer treat leases as 'off-balance sheet' items. Previously, if you leased an asset such as a van or an office, the total liability didn't technically exist in your formal accounts; it showed up as a regular monthly expense in your profit and loss. While you were committed to the payments, the asset and the total underlying debt stayed off your balance sheet.
Now, you are required to account for the full, long-term value of the lease from day one. Instead of just tracking a monthly payment, two key figures will now sit permanently on your balance sheet:
| A Right-of-Use (ROU) Asset | A Lease Liability |
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Refers to your right to use the leased asset. It includes the lease payments you’ve agreed to make, plus any upfront costs such as legal fees or broker commissions.
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This is the total amount you’re committed to pay your landlord or finance provider over the life of the lease, adjusted to reflect its value in today’s terms.
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The 'Front-Loaded' Effect
These changes don't just alter where items sit on your balance sheet; they change when costs impact your bottom line. Under the new rules, leases are treated in a similar way to loans. This means each monthly payment is separated into two categories:
- Interest: Calculated on the outstanding balance of your lease liability.
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Depreciation: Representing the cost of using the asset over its useful life.
Much like a loan, you’ll notice that the overall cost of a lease is higher at the start of the term, creating a 'front-loaded' effect on your expenses. This happens because interest is calculated on the remaining lease liability. In the early days, when the liability is at its highest, the interest portion of your payment is also at its peak. As you pay down the balance over time, the interest charge naturally tapers off in the later years.
Even though the actual cash leaving your bank account remains exactly the same each month, this accounting treatment means your total reported expenses will often be higher in the early years of a lease.
This leads to three main outcomes:
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Lower Profits at the Start: Your reported profits may appear lower in the early stages of a lease due to those higher initial interest charges. It’s important to communicate this to stakeholders, so they understand it’s an accounting transition, not a dip in performance.
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Inflated EBITDA: Because lease costs move from "operating expenses" into "interest and depreciation," your EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortisation) will often look higher. Savvy investors and lenders will likely "strip back" these inflated figures to assess your true cash flow and business value.
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More Visible Debt: Your balance sheet will now reflect the total value of the lease as a liability. This visible debt is something to monitor closely, as it could influence your credit rating, borrowing capacity, or any existing bank covenants.
Defining a Lease Under FRS 102
A lease is an agreement where a lessor (the owner) gives a lessee (you) the right to use an asset for a set period of time in exchange for payment.
While this definition is broad enough to cover everything from a fleet of delivery vans to a single software licence, tracking every minor agreement would be an administrative overload. To keep your reporting manageable and focused on what matters, FRS 102 provides two key exemptions:
1. Low-Value Assets
If an asset is relatively inexpensive when purchased new, you aren't required to recognise it on your balance sheet. Although there is no fixed statutory limit in the UK, many SMEs apply a practical threshold (often around £5,000). This typically covers items such as:
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Laptops, tablets, and desktop PCs
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Office telephony systems
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Standard office furniture
Certain assets are excluded from this exemption regardless of their age or value. Cars, vans, and property leases are almost always treated as "on-balance sheet" items.
2. Short-Term Leases
Leases with a maximum term of 12 months or less (which do not include an option to purchase the asset) can stay off the balance sheet. This is a common solution for "pop-up" retail spaces or the short-term hire of specialist plant machinery for a specific contract.
Can FRS 102 Rules Affect Your Audit Status?
The short answer is: Yes, it’s possible!
An audit isn't triggered solely by your turnover; it is also based on the value of the assets you hold. Since you now have to list most leases as 'assets' on your balance sheet, this can significantly inflate your gross asset value compared to previous years. For companies already sitting near the 'small company' limits, this alone could be enough to push you over the threshold.
Generally, a UK company requires a statutory audit if it meets two or more of the following criteria for two consecutive financial years (often referred to as the 'two-year rule'):
Audit Thresholds (Financial years beginning on or after 6 April 2025)
| Criteria | Threshold |
| Gross Assets | Over £7.5 million (including leased assets) |
| Annual Turnover | Over £15 million |
| Headcount | More than 50 employees |
The Credibility Factor: Transparency & Reporting
The latest updates to FRS 102 require a much more detailed breakdown of your leasing activity in your accounts. Although this means having to provide more information, this transparency ensures that anyone with an interest in your business, whether that’s a bank, a potential investor, or a future buyer, can see the full scale of your financial commitments.
Here is what you’ll be sharing in your next set of accounts:
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Right-of-Use Assets: You will now clearly show the value of the assets you control through leasing agreements, such as office space, vehicles, or equipment/machinery, directly on your balance sheet.
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Lease Liabilities: Rather than hiding future payments in the notes, the total present value of your future lease obligations will be recorded as a formal liability.
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Depreciation and Interest Charges: Instead of a single operating lease expense, your profit and loss account will show the depreciation of the leased asset and the interest incurred on the lease liability.
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Short-term and Low-value Exemptions: You will need to specify which leases you have excluded from the balance sheet, such as those with a term of 12 months or less or items of low value.
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Variable Lease Payments: Any payments that vary based on an index or rate will be more clearly defined, providing a more accurate picture of potential cash flow fluctuations.
Preparing for FRS 102: Your Essential Checklist
Taking proactive steps will help you stay in control of your business's finances and ensure you stay on the right side of HMRC and the Financial Reporting Council.
1. Check Your Existing Contracts
Start by listing every rental or hire agreement your business currently has. This includes:
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Property: Main office, retail space, or warehouse leases.
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Transport: Your vehicle fleet or delivery vans.
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Equipment: Specialist machinery like forklifts or even your office printers.
2. Review Your Borrowing Agreements
Check your bank loan agreements for any "restrictive covenants." Because FRS 102 changes how debt and assets appear on your balance sheet, it could impact your gearing ratios. It is wise to speak to your bank early to ensure you remain in compliance with their lending terms.
3. Formalise Property Use
If you operate out of a property owned by a director or a "connected company" without a formal lease, you need to act now. Clearly document and agree on how long the business intends to use the space.
4. Build with an Audit-Ready Mindset
Even if your turnover hasn't reached the mandatory audit threshold yet, establishing these habits early is a smart move. By treating your accounts as though an audit is already required, you’ll avoid a last-minute scramble if you do cross the thresholds in a future year.
5. Optimise Your Cloud Accounting
Ensure your software, such as Xero or QuickBooks, is configured to handle the new interest and depreciation entries automatically. Moving away from manual spreadsheets reduces the risk of errors during your year-end accountancy and compliance work.
