Don’t lease it too late to start thinking about ‘FRED’ 82
We’ve known about ‘FRED’ 82 for some time now, but have you really digested what this means for your business?
Do you know which of your KPIs, covenants and remuneration schemes will be impacted and by how much? Have you identified all your lease arrangements and understood the terms?
We know the prospect is time-consuming, and complex, but setting up a clear project plan and team is key to a successful, low-stress adoption of the new standards and establishing efficient BAU processes – and KPMG is here to support you through the process.
What is ‘FRED’ 82 and when will it take effect?
Financial Reporting Exposure Draft 82 (‘FRED 82) was issued in December 2022 by the Financial Reporting Council (‘FRC’) and proposes several major changes to the current FRS 102 standard. The key changes are alignment with IFRS 15: Revenue from Contracts with Customers and IFRS 16: Leases.
Following conclusion of the consultation period on 30 April 2023, the FRC is now in the process of finalising this amendment and it is expected that the standard will be released in the first half of 2024.
FRED 82 has an anticipated effective date for accounting periods beginning on or after 1 January 2026. At face value, this seems quite far away, but you will need to collect data, make accounting judgements and implement systems/tools ahead of this date.
A key aspect of getting ahead is to be able to manage the impacts on KPIs with external stakeholders like investors and lenders.
What are the proposed changes to lease accounting?
FRED 82 proposes to mirror the approach under IFRS 16: Leases. Existing operating leases under FRS 102 will be brought on-balance sheet.
Liability: A lease liability will be recognised, reflecting the obligation to make lease payments over the lease term. The liability is the present value of future lease payments and will unwind as an interest expense. Lease payments will reduce the liability.
Asset: A right-of-use asset will also be recognised and depreciated over the lease term. This will typically be measured equal to the initial lease liability, with some potential adjustments.
P&L: Depreciation on each leased asset will be recognised as an expense. The lease liability will unwind as an interest expense over the lease term.
These balances aren’t set and forget however, regular reassessment is required, for example when there is indexation, a rent review, or a change in the expected lease term. Changes which are made outside of the existing lease terms (such as an increase or decrease in the scope of the lease) may have to be accounted for a lease modification and these can be complex.
But what’s the good news?
Aside from KPMG’s support, it is also important to note that the FRC has included some optional simplifications within FRED 82 to ease the transition process. The key simplifications being:
- Discount rates: Instead of needing to determine an incremental borrowing rate (an ‘IBR’) where the implicit rate is not known, FRED 82 proposes the use of an Obtainable Borrowing Rate (OBR), a less complex version. In limited circumstances, the proposal also allows the use of a ‘backstop’ for entities to use a gilt rate where neither the IBR nor OBR are available.
- Low value and short-term lease exemptions: Like IFRS 16: Leases, FRED 82 also allows adopters to benefit from low-value assets and short-term leases (i.e. less than 12 months) being exempt from on-balance sheet accounting.
- Lease Modifications: FRED 82 is structured so that fewer lease contract modifications will require a new discount rate to be determined.
Where do I start?
If you haven’t already, we recommend that you perform an initial impact assessment to better understand how the proposed changes will affect your business. To do this, you should ask yourself the following questions:
- What is my lease portfolio? – do I have any embedded leases in non-lease contracts.
- Do I have copies of all the lease arrangements? Can I obtain these? – as data will need to be extracted and maintained.
