Are you prepared for the changes to FRS 102?

It may have rightly passed you by, but on 15^th December last year, with Santa warming up his sleigh for his annual global expedition, the Financial Reporting Council issued an early Christmas present in the form of Financial Reporting Exposure Draft 82 (‘FRED 82’), proposing various changes to the suite of standards that make up UK GAAP.

The ED proposes amendments to FRS 102: The Financial Reporting Standard to provide greater consistency and alignment to international accounting standards including;

• a new model for revenue recognition, aligned to IFRS 15: Revenue from Contracts with Customers, but with some simplifications;
• on balance sheet lease accounting for lessees with certain practical exemptions aligned to IFRS 16: Leases; and
• other modifications resulting from the FRC’s review of developments in international accounting standards (including current proposals for amendments to the IFRS for SMEs Standard) and changes suggested by respondents to the FRC’s call for views on the periodic review of UK GAAP conducted in 2021.

Although the headline changes focus on revenue recognition and lease accounting, there are a number of areas of change including the adoption of the IFRS 13 definition of fair value, guidance on factors to consider when accounting for uncertain tax treatments and new guidance on business combinations that finance teams should consider.

The changes to revenue recognition centre around the introduction of a new five step model for revenue recognition, very much aligned to IFRS 15. However, the use of ‘performance obligations’ in a contract, which has provided many challenges under IFRS 15, has been subtly replaced by ‘promises’ to provide simplicity.

We saw with IFRS 15, the level of transition adjustments varied by sector, and we expect the same here under FRS 102 with potential amendments to the timing of revenue recognition.  We would expect companies to review their customer contracts in detail to apply the guidance and, as we found under IFRS 15, this can be more complex than initially appears.

Other simplifications to the international framework to provide for a smoother transition include the policy choices on the treatment of costs to obtain a contract and allocating discounts across periods.

The adoption of a single lease accounting model for lessees has been introduced. The on/off balance sheet question for all leases held by a lessee has been an age-old debate in the accounting profession. Bringing previous operating leases onto the balance sheet and replacement of a lease charge with depreciation and interest may have a significant impact on the financial statements of UK GAAP reporters. Similar to revenue, the changes will require you to review your lease contracts to determine what is in and out of scope of the standard and form a methodology for calculating lease liabilities and their corresponding assets.

It should be noted, however, that the standard setters have helpfully provided some practical simplifications in comparison to international standards, especially in respect of the transition to the standard, the calculation of discount rates and low value assets.  Entities who already produce IFRS 16 numbers for consolidation purposes will also be able to use those numbers on transition to the new rules, which is good news.

The commercial impacts of the new requirements may be wide reaching, and considerations could include;

• How will the amendments affect your business valuation; either where revenue recognition is accelerated or spread over a longer period of time?
• Will any covenants need to be reset if EBITDA/net debt is adjusted especially with the lease accounting changes?
• How will you amend current remuneration, bonus and share option schemes where reward is directly linked to the financial performance of the business?
• Will dividend payments be restricted if distributable reserves are eroded by transition adjustments.

Although the standards will only be effective, subject to endorsement, for accounting periods beginning on or after 1 January 2026, we would encourage companies to plan today for adopting these changes. Transition can take time depending on the amendments required to your existing accounting policies.

Firstly, performing an initial impact assessment is advised to understand the likely areas of impact for your financial statements, whether that be profit or loss or balance sheet. From that, calculations can be performed over the key areas impacted to understand the likely quantitative impact of transition ahead of a 1 January 2026 adoption date.

Also, don’t forget the disclosure impact: the revenue recognition and lease changes will require increased disclosures in your financial statements from previous years; this will provide more information to the readers of your accounts, some of which may be sensitive around future revenue.

KPMG’s Accounting Advisory Services team are on hand to help and support you with the transition. Our team of technical accountants has significant experience in accounting standard changes including the adoption of IFRS 15 and IFRS 16 for international standard adopters. Do please reach out if you require support or require further information.