In March 2024, Financial Reporting Council issued a comprehensive set of amendments to FRS 102, The Financial Reporting Standard applicable in the UK and Republic of Ireland. This update is the result of the FRC's second periodic review, a crucial exercise designed to ensure UK and Ireland accounting standards remain high-quality, relevant, and proportionate. The most substantial changes bring FRS 102 into closer alignment with major International Financial Reporting Standards (IFRS), specifically IFRS 16 on leases and IFRS 15 on revenue from contracts with customers.
The overarching objective is to enhance the reliability of financial statements for users like investors and lenders, which in turn supports better access to capital and fosters growth. The FRC has balanced this by introducing proportionate changes designed to remove unnecessary reporting burdens where possible, while implementing more robust frameworks for complex transactions. The result is a standard that will provide better, more transparent information to stakeholders.
For most entities, the amendments are mandatorily effective for accounting periods beginning on or after 1 January 2026. However, a key exception is the new disclosure requirements for supplier finance arrangements, which have an earlier effective date for periods beginning on or after 1 January 2025. Early application is permitted, but this requires an "all-or-nothing" approach, where all amendments from the periodic review must be adopted at the same time.
This article provides a detailed analysis of the most significant changes, offering practical insights and a strategic roadmap to help your organization navigate a smooth and compliant transition.
Headline Amendment 1: The New On-Balance Sheet Lease Model (Section 20)
The most significant operational and financial statement change for many entities is the complete overhaul of lease accounting for lessees. This amendment marks a fundamental paradigm shift, moving away from the previous distinction between operating and finance leases. Aligned with the principles of IFRS 16, the new model requires lessees to recognize nearly all leases on the balance sheet, providing a more faithful representation of an entity's assets and liabilities.
Core Changes for Lessee Accounting
Under the amended Section 20, lessees must recognize a right-of-use (ROU) asset and a corresponding lease liability for almost all lease contracts.
The lease liability is initially measured at the present value of future lease payments that are not paid at the commencement date. These payments are discounted using an appropriate interest rate. While the interest rate implicit in the lease should be used if readily determinable, the standard provides a key simplification: if the implicit rate cannot be determined, the lessee can use its ‘obtainable borrowing rate’ (OBR). The OBR is simpler to determine than an incremental borrowing rate because it focuses on the monetary value and term of the lease, not the specific nature or location of the underlying asset.
The ROU asset is initially measured at cost. Its value is derived from a clear build-up of components:
Start with the initial measurement of the lease liability. Add: (1) Lease payments made before the commencement date. (2) Initial direct costs incurred by the lessee (e.g., commissions, legal fees). (3) An estimate of costs to dismantle, remove, or restore the underlying asset. Subtract: Any lease incentives received.
Recognition Exemptions
To ensure proportionality, the FRC has provided two key recognition exemptions that allow lessees to continue accounting for certain leases off-balance sheet, recognizing the lease payments as an expense on a straight-line basis. These exemptions can be applied to:
Short-term leases: Defined as leases with a term of 12 months or less at the commencement date. This election is made by class of underlying asset.
Leases of low-value assets: This assessment is based on the absolute value of the underlying asset when it is new, not its materiality to the lessee. The standard clarifies that assets such as motor vehicles, land, buildings, and production line equipment would not be considered low-value. Examples of low-value assets could include tablets, personal computers, and small items of office furniture.
Impact on Financial Statements and Business Operations
The transition to an on-balance sheet model will have far-reaching consequences for many businesses. Key impacts include:
Profit & Loss: The straight-line operating lease expense will be replaced by two separate charges: a depreciation charge on the ROU asset and an interest expense on the lease liability. This creates a "front-loaded" expense profile, with higher total expenses recognized in the earlier years of a lease and lower expenses in the later years.
EBITDA: As operating lease rental expenses are removed and replaced by depreciation and interest, Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) will increase. This is a change in presentation and not in underlying cash flows, but it will affect how performance is measured.
Balance Sheet: Gross asset values will increase due to the recognition of ROU assets. Liabilities will also increase, which will impact key metrics such as gearing ratios and net current assets. For some companies, this increase in gross assets could affect their eligibility for certain size thresholds under company law.
Covenants: The significant changes to assets, liabilities, and EBITDA could have a direct impact on banking and finance covenants. We advise clients to begin immediate engagement with lenders to discuss these effects and manage any potential breaches.
Transition and Practical Expedients
For leases, the FRC has mandated a modified retrospective approach. This means that comparative information is not restated. Instead, the cumulative effect of applying the new standard is recognized as an adjustment to the opening balance of retained earnings on the date of initial application (e.g., 1 January 2026 for a December year-end).
To simplify this transition, several practical expedients are available to lessees:
The option to not reassess whether a contract is, or contains, a lease at the date of initial application for existing contracts.
Entities that already calculate lease balances under IFRS 16 for group reporting purposes can use those carrying amounts as their opening balances on transition.
The use of hindsight is permitted when assessing the lease term (e.g., determining whether an extension option is reasonably certain to be exercised) at the date of transition.
A single discount rate can be applied to a portfolio of leases with similar characteristics, saving the effort of calculating individual rates.
The short-term lease exemption can be applied to existing leases that have a remaining term of less than 12 months at the transition date.
It is important to note that lessor accounting remains largely unchanged, with lessors continuing to classify leases as either operating or finance leases. The move to on-balance sheet accounting is a significant undertaking for lessees, but these changes are matched in importance by the new framework for revenue recognition.
Headline Amendment 2: The Five-Step Revenue Recognition Model (Section 23)
The second cornerstone of the FRS 102 amendments is the introduction of a new, comprehensive revenue recognition model in Section 23. This change aligns UK GAAP with the five-step model from IFRS 15, representing a significant shift in principle. The focus moves away from the previous concept of transferring risks and rewards to a control-based approach centered on identifying and satisfying distinct "performance obligations" owed to a customer.
The new model provides a single, robust framework for all contracts with customers. The five steps are as follows:
Identify the contract(s) with a customer. A contract is an agreement that creates enforceable rights and obligations. The model applies when a contract meets specific criteria, including that all parties are committed and it is probable that the entity will collect the consideration.
Identify the performance obligations in the contract. A performance obligation is a promise to transfer a distinct good or service to a customer. A good or service is "distinct" if the customer can benefit from it on its own and the promise to transfer it is separately identifiable from other promises in the contract. This step may require "unbundling" contracts into separate components.
Determine the transaction price. The transaction price is the amount of consideration an entity expects to be entitled to in exchange for transferring the promised goods or services. This requires estimating any variable consideration, such as discounts, rebates, refunds, and performance bonuses.
Allocate the transaction price to the performance obligations. For contracts with multiple performance obligations, the transaction price is allocated to each one based on its relative stand-alone selling price. This is the price at which the entity would sell the good or service separately to a customer.
Recognize revenue when (or as) the entity satisfies a performance obligation. Revenue is recognized as control of a good or service is transferred to the customer. This can occur either "over time" (e.g., for a continuous service) or "at a point in time" (e.g., upon delivery of a product).
Key Accounting Considerations
The five-step model introduces specific guidance for several complex areas:
Variable Consideration: This must be estimated using either an "expected value" or "most likely amount" method. Crucially, it is only included in the transaction price to the extent that it is "highly probable" the entity will be entitled to it and a significant reversal of cumulative revenue will not occur.
Contract Costs: Entities have an accounting policy choice to recognize an asset for the incremental costs of obtaining a contract (e.g., sales commissions) if those costs are expected to be recoverable. Otherwise, they are expensed as incurred. As a practical expedient, costs that will be fully amortized within one year may be expensed when incurred, even if a policy of capitalization has been chosen.
Principal vs. Agent: An entity must determine if it is a principal or an agent in a transaction. Indicators include whether the entity is primarily responsible for fulfilling the promise, holds inventory risk, or has discretion in setting prices. A principal recognizes revenue on a gross basis, while an agent recognizes only its fee or commission.
Warranties: A warranty is treated as a separate performance obligation if it provides the customer with a service in addition to the assurance that the product complies with agreed-upon specifications. If it is not a separate service, the costs are accounted for as a provision under Section 21.
Transition Options and Expedients
Unlike the mandatory approach for leases, preparers have a choice of two transition methods for revenue recognition, each with its own set of practical expedients.
Full Retrospective Approach: This approach requires restating comparative information for prior periods to the earliest date which is practicable, as if the new Section 23 had always been applied. The adjustment is made to the opening equity of the earliest period presented. An entity does not need to restate contracts that begin and end within the same annual reporting period, or that were completed at the start of the earliest period presented. For contracts with variable consideration completed by the reporting date, the entity may use the final transaction price rather than estimating it for comparative periods.
Modified Retrospective Approach: Under this approach, an entity recognizes the cumulative effect of the change as an adjustment to the opening balance of retained earnings on the date of initial application. This approach is applied only to contracts that are not completed at that date, and comparative information is not restated. For contracts modified before the date of initial application, an entity does not need to retrospectively restate for those modifications. Instead, the aggregate effect of all modifications can be reflected when identifying performance obligations and allocating the transaction price at the transition date.
While the changes to leases and revenue are the most substantial, the periodic review has refined many other areas of FRS 102, which also require careful consideration.
Analysis of Other Key Amendments by Section
Beyond the headline changes to leases and revenue, the 2024 periodic review introduced a host of other important amendments, improvements, and clarifications across FRS 102. These changes are designed to enhance consistency, align with international best practices, and address areas of ambiguity. This section systematically evaluates the most impactful of these other amendments.
Section 2: Concepts and Pervasive Principles: This foundational section has more than doubled in size, aligning it with the IASB’s Conceptual Framework. It introduces revised definitions of core elements like assets and liabilities, shifting the focus towards rights and obligations rather than simply the flow of economic benefits. Preparers should note that to avoid unintended consequences, certain definitions (such as for provisions and share-based payments) have been intentionally retained from the previous standard. A review of accounting policies against these new principles is a critical transition step.
Section 2A - Fair Value Measurement: A new section, Section 2A, has been introduced to align FRS 102's fair value measurement principles more closely with IFRS 13. It provides an updated definition of fair value, focusing on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (an exit price). This change is applied prospectively from the date of transition, meaning no retrospective adjustments are required.
Sections 3 & 8 - Material Accounting Policy Information: A subtle but significant change in wording requires entities to disclose ‘material accounting policy information’ in place of ‘significant accounting policies’. This is a crucial shift in emphasis, moving away from generic policy descriptions towards entity-specific information that users would need to understand other material items in the financial statements.
Section 7 - Supplier Finance Arrangements: In response to the growing use of these arrangements, new disclosure requirements have been added to Section 7, Statement of Cash Flows. Entities must now disclose key terms and conditions of arrangements where a finance provider settles supplier invoices on the entity's behalf. This amendment has an earlier effective date of 1 January 2025, and comparative information is not required in the first year of application.
Sections 11 & 12 - Financial Instruments: The option to newly adopt IAS 39 as an accounting policy for financial instruments is now prohibited. This change restricts entities from moving to this older standard, unless it is to align with the accounting policies of a consolidating parent. Entities already applying IAS 39 can continue to do so.
Section 18 - Intangible Assets: New guidance clarifies how to account for assets with both tangible and intangible elements. The accounting is based on which element is more significant. For example, software that is integral to a machine and without which the machine cannot operate is treated as part of the tangible asset (Property, Plant and Equipment).
Section 19 - Business Combinations: The guidance on business combinations has been enhanced by incorporating key concepts from IFRS 3. This includes more detailed guidance on identifying the accounting acquirer, particularly in complex merger or reverse acquisition scenarios. It also helps distinguish payments that are part of contingent consideration from those that are remuneration for ongoing employee services. These amendments are applied prospectively to business combinations occurring on or after the transition date.
Section 26 - Share-Based Payments: A number of specific amendments have been made to provide clearer guidance. These include clarifying scope exclusions for instruments issued in a business combination in exchange for control, accounting for awards where the counterparty has a choice of settlement, and incorporating vesting conditions into the fair value of cash-settled liabilities.
Section 29 - Income Tax: New guidance has been introduced for accounting for uncertain tax treatments, based on the principles of IFRIC 23. An entity must recognize an uncertain tax treatment only if it is probable that the tax authority would accept the position if it were examined with full knowledge of all relevant information. On transition, preparers have an accounting policy choice to either restate comparatives or recognize the cumulative effect of the change in equity.
These widespread changes will have varying implications depending on an entity's size, sector, and legal form.
Specific Implications for Different Entity Types
The FRS 102 amendments do not apply uniformly across all reporting frameworks. The consequences vary for small entities, charities, LLPs, and micro-entities, reflecting the FRC's goal of proportionate financial reporting. This section details the key considerations for these specific entity types.
Increased Disclosure Burden for Small Entities (Section 1A)
Small entities applying Section 1A of FRS 102 face a significant increase in mandatory disclosure requirements. Previously, many of these disclosures were only "encouraged," but they are now required to ensure financial statements provide a true and fair view and to reduce the level of judgment required from preparers. Key new mandatory disclosures include those related to:
Going concern, including any significant judgments made in the assessment.
Provisions and contingent liabilities/assets, including reconciliations of movements in provisions.
Share-based payments, describing arrangements and disclosing expenses recognized.
Deferred taxes, including movements and unrecognized deferred tax assets.
Dividends paid, disclosed separately for each class of share.
Related party transactions, where the judgment related to "normal market conditions" has been removed, meaning all such transactions will now require disclosure.
Crucially, preparers must note that these new disclosure requirements also apply to the comparative information presented in the first year of adoption.
Considerations for Charities and LLPs (SORPs)
The Statements of Recommended Practice (SORPs) for both charities and LLPs have been updated to reflect the amendments to FRS 102.
For charities, the 2026 SORP introduces a new three-tier reporting regime based on gross income, with increased disclosure and presentation requirements for larger charities. Charities will need to carefully assess their income streams to apply the new five-step revenue model and will face significant balance sheet changes from the on-balance sheet lease model.
For LLPs, the updated SORP reflects the FRS 102 changes as well as recent updates to company law, including the increased size thresholds for determining if an LLP qualifies as small.
Micro-entities (FRS 105)
The impact on the smallest entities reporting under FRS 105 is mixed:
The new five-step revenue recognition model from Section 23 does apply to micro-entities, albeit with some further simplifications. A micro-entity is required to apply the changes prospectively to contracts that begin after the date it first applies the amendments.
Crucially, the new on-balance sheet lease accounting model from Section 20 does not apply to FRS 105 preparers. They will continue with the existing lease accounting treatment, maintaining the distinction between operating and finance leases.
With these diverse impacts in mind, all entities must begin developing a clear strategy for adoption.
A Strategic Roadmap for Implementation
As the mandatory effective date of 1 January 2026 is upon us, the scale and complexity of these amendments demand immediate and proactive planning. Finance teams that underestimate the implementation effort risk facing significant challenges with data gathering, system changes, and stakeholder communication. A structured approach is essential for a smooth and successful transition.
The following checklist outlines a strategic roadmap of practical actions for businesses to undertake if not already started:
Conduct an Impact Assessment: Begin a comprehensive review of all customer contracts and leasing arrangements. The goal is to identify the precise accounting, system, and disclosure impacts of the new revenue and lease models. This assessment should quantify the potential changes to key financial metrics.
Engage with Stakeholders: Initiate early discussions with key stakeholders, particularly lenders, investors, and board members. Explain the anticipated impact on financial statements and key performance indicators like EBITDA, gearing, and profit. Proactively renegotiating or clarifying the terms of any debt covenants that may be affected is critical.
Gather Necessary Data: The new standards require data that may not be readily available in current systems. Start identifying data gaps and establish processes to collect this information, such as stand-alone selling prices for revenue allocation, lease-specific discount rates, and the data points needed for the new mandatory disclosures for small entities under Section 1A.
Evaluate Transition Options: For revenue recognition, carefully assess the two available transition methods; full retrospective versus modified retrospective. The choice will depend on the complexity of your contracts, the availability of historical data, and the needs of your stakeholders. This decision should be made early, as it dictates the entire implementation project.
Upskill Finance Teams: Implementation should begin with targeted training and workshops to upskill your finance team on the new requirements. A deep understanding of the principles behind the new lease and revenue models is fundamental to making accurate judgments and applying the standards correctly.
Review Accounting Policies and Judgments: The amendments introduce new definitions and concepts that demand a thorough review of all existing accounting policies, key judgments, and estimation techniques to ensure they align with the updated principles. This is particularly critical given the revised definitions of assets and liabilities in Section 2.
The 2024 amendments to FRS 102 are among the most substantial changes to UK and Ireland GAAP in a decade. A proactive and well-planned implementation strategy is not just advisable, it is essential for ensuring a smooth, compliant, and successful transition to the new standards.
We hope you find this in-depth treatment of these significant changes to UK GAAP useful. For advice on your specific circumstances, feel free to reach out to us.