Changes to UK GAAP: amendments to lease accounting

On 27 March 2024, the FRC issued amendments to FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland and other FRSs – Periodic Review 2024. The key changes are alignment with IFRS 15: Revenue from Contracts with Customers and IFRS 16: Leases.

The effective date for most amendments is periods beginning on or after 1 January 2026, with early adoption permitted. 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.

The changes to UK GAAP will 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.

Aside from KPMG’s support, it is also important to note that the FRC has included some optional simplifications within revised FRS 102 to ease the transition process. The key simplifications being:

• Use of an ‘obtainable borrowing rate’ instead of ‘incremental borrowing rate’.
• Guidance on application of the low value definition.
• Reduced modification triggers requiring a revised discount rate.
• Simpler approach to recognising gains/losses for sale and leaseback transactions.

If you haven’t already, we recommend that you perform an initial impact assessment to better understand how the 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.

Our team can help support your business through the transition, including through:

• Training/workshops – in-person or virtual classroom training/workshops tailored for finance teams to bring you up to speed on the new requirements and how they apply to your business.
• Impact assessment – We can support with evaluating the potential impacts of the proposed lease requirements on your business and financial statements.
  
• Financial modelling – We can provide a lease model to calculate the impact of the changes to UK GAAP and prepare the required journal entries on an ongoing basis.
  
• Accounting policies – We can prepare/review your lease accounting papers/policies and support with the key accounting judgements. Contract reviews may be required.
  
• Disclosure requirements – We can identify the disclosure impacts for your business and assist with updating the existing disclosures to comply with the proposed changes.

FRS 102 currently allows preparers to recognise and measure their financial instruments using any of the following policies: (1) Sections 11 and 12 of FRS 102; (2) IAS 39; or (3) IFRS 9.

The amendments prohibit option 2 (IAS 39), either on transition to FRS 102 or through a voluntary change in accounting policy, unless it makes the preparer’s policy consistent with those of its consolidating parent.

However, preparers already applying IAS 39 prior to the amendment can continue to do so. Those who currently don’t but wish to apply IAS 39 to account for their financial instruments would need to change their policy before the amended standards become effective, unless they are able to change the policy after transition to align with their consolidating parent’s policy.

The amendments include guidance on how an asset with both intangible and tangible elements should be accounted for depending on which element is more significant. For example, software for a machine that cannot operate without that specific software is an integral part of the related hardware and is treated as a tangible asset.

Preparers will need to review their fixed assets to identify assets with both tangible and intangible elements and decide whether any reclassifications are needed on transition.

Certain IFRS 3 concepts such as identifying the accounting acquirer (including when a Newco is formed) and distinguishing contingent consideration from remuneration for ongoing services have been incorporated through the amendments.

This may change how FRS 102 preparers identify the accounting acquirer in complex business combinations (such as in mergers or reverse acquisitions) and post-acquisition remuneration mechanisms such as earn-out clauses.

A number of specific amendments have been made which include scope exclusions in business combinations, accounting for equity-settled share-based payments within equity or as an expense, incorporating vesting conditions in determining fair value of cash-settled liabilities, and accounting for awards where the counterparty has a choice of settlement that includes a net settlement feature.

Given the specificity of the changes and the lack of previous guidance, FRS 102 preparers may have applied alternative accounting approaches to the areas of amendment which could require adjustment on implementation.

Preparers with share-based payments should start reviewing current and future anticipated share-based payment arrangements to assess whether they fall in scope of the amendments.

Although FRS 102 is currently silent on uncertain tax treatments, the amendments introduce guidance based on IFRC23 Uncertainty over Income Tax Treatments that uncertain tax treatments are recognised only if it’s probable that the tax authority has full knowledge of relevant information and would accept the position if examined.

FRS 102 preparers should assess whether any unresolved uncertain tax positions at the transition date and consider whether they need to be recognised to align with the amended guidance which may increase the likelihood of preparers recognising certain tax uncertainties on the balance sheet.

Other amendments also impact the following areas:

• Related party disclosures (Section 33) – disclosure of amount of related party commitments.
• Employee benefits (Section 28) – estimates and assumption used to remeasure defined benefit plans
• Borrowing costs (Section 25) – exclusion of specific borrowings from the capitalisation rate for general borrowings.
• Equity (Section 6) – disclosure of dividends paid separately for each class of shares.
• Specialised activities (Section 34) – various alignment amendments, as well as guidance on heritage assets, and non-exchange transactions for public benefit entities.

Amendments relating to supplier finance arrangements are effective from accounting periods beginning on or after 1 January 2025 with early application being permitted. Comparative information is not required in the year of adoption.

All other amendments are applicable from accounting periods beginning on or after 1 January 2026 and early application is permitted provided all amendments are applied at the same time.

The amendments are applied retrospectively other than fair value measurement and business combinations which are applied prospectively. There is also an option for retrospective amendments to uncertain tax treatments to be cumulatively reflected in equity rather than restating comparatives.

KPMG’s Accounting Advisory Services team are on hand to help and support preparers with implementation of the FRS 102 amendments.

Typically implementation starts with a workshop to kick off the project and upskill your team, followed by an impact assessment, preparation of accounting papers, quantification and disclosure. Do please reach out if you would like to talk to our specialists.