The Financial Reporting Council (FRC) has updated FRS 102, leading to major changes for UK companies that follow these accounting rules. The most significant changes relate to Section 20: Leases. These new rules apply to accounting periods starting on or after 1 January 2026, but companies can choose to adopt them early if they implement all changes at once.
In this blog, we’ll explain what has changed, who will be affected, how these changes could impact your business, and practical steps to help your organisation comply with these changes.
1. What has changed in Section 20: Leases of FRS 102?
Previously, Section 20: Leases of FRS 102 was based on IAS 17, requiring lessees to classify leases as either “operating” or “finance leases.” Operating leases were off-balance sheet meaning rent was charged to Statement of Profit and Loss as an expense, while only finance leases appeared on the balance sheet.
The amendments to Section 20 bring a paradigm shift:
- Most leases will now appear on the balance sheet for lessees, excluding short-term leases and leases of low-value assets (such as laptops, mobile phones etc.).
- The distinction between operating and finance leases for lessees has been removed. Instead, lessees will recognise a “right-of-use” asset and a corresponding lease liability for nearly all leases.
- This new model closely aligns with IFRS 16 but retains some simplifications suitable for the UK’s SME landscape.
- Lessor accounting remains largely unchanged under Section 20, focusing changes on the lessee side.
Transition:
Lessees are required to apply a modified retrospective approach on transition to revised Section 20.
A lessee must not restate its comparative figures and, instead, it recognises the cumulative effect of initially applying the amendments as an adjustment to the opening balance of “Retained earnings” on the date of initial application.
As a practical expedient, a lessee that is already preparing IFRS 16 information for the purpose of consolidated financial statements is permitted to transition to revised Section 20 by recognising the IFRS 16 carrying amounts of its right-of-use assets and lease liabilities at the date of initial application.
If the above practical expedient is not available or is not taken, the lessee measures, for each lease previously classified as an operating lease:
- The lease liability by discounting the remaining lease payments using either the IBR or OBR at the date of initial application; and
- The right-of-use asset at an amount equal to the lease liability, adjusted by the amount of any prepaid or accrued lease payments recognised on the balance sheet immediately before transition.
2. Who will be impacted by these changes?
The amended Section 20 will affect:
- All lessees under FRS 102 (UK companies and groups, charities, and non-profits with leasehold property, vehicles, or equipment), except for those reporting as micro-entities under FRS 105.
- Entities with significant operating lease portfolios—such as retailers, transport and logistics firms, real estate businesses, leisure and hospitality sectors, will see the most noticeable effects.
- Entities with existing debt covenants should be especially alert: new lease liabilities will increase reported gearing and could affect covenants and access to financing.
3. How will these amendments impact entities?
Key impacts include:
- Balance Sheet growth: Lessees will typically report more assets and more liabilities due to capitalised leases, potentially affecting financial ratios, borrowing capacity, and perceptions of financial health.
- Profit & Loss volatility: Lease expense recognition shifts from straight-line rental charges to depreciation and interest, which will typically increase expense early in a lease’s life and reduce it towards the end.
- Covenant Risks: Loan covenants tied to metrics such as gearing, EBITDA, or net debt may need renegotiation or monitoring, as the new liabilities can push these ratios higher, risking breaches.
- Systems and Process overhauls: More leases on the balance sheet mean entities need robust lease data collection, updated accounting systems, and thorough staff training to handle the new requirements.
4. Compliance Roadmap: Steps to Prepare for Section 20 Amendments
To ensure timely and successful compliance, UK entities should take the following steps:
- Review Lease Inventories - Identify all lease contracts, including embedded leases, to assess which fall within the scope of Section 20.
- Assess Impact - Model the effect on balance sheet, income statement, and key financial covenants.
- Engage with Lenders and Stakeholders - Discuss anticipated financial statement changes with banks or finance providers to pre-empt covenant breaches or renegotiations, update board and audit committees.
- Update Accounting Systems - Ensure accounting software can track right-of-use assets, lease liabilities, and related amortisation and interest calculations, enhance processes for ongoing lease data collection and contract management.
- Train Finance Teams - Educate staff in finance, operations, and procurement on policy and process changes.
- Review Policies and Disclosures - Update accounting policies especially around transition choices and exemption elections, consider early adoption if beneficial to the group or for comparability within your peer set.
- Plan Early - Start gathering data and performing impact assessments as soon as possible. Don’t wait until the 2026 effective date.
5. Summary Table: Section 20 Key Changes vs. Old Rules
| Topic | Old Section 20 (IAS 17 model) | New Section 20 (IFRS 16 model) |
|---|---|---|
| Lessee: Operating Leases | Off-balance sheet | On-balance sheet as ROU asset & liability |
| Lessee: Finance Leases | On-balance sheet | On-balance sheet |
| Lease Expense Recognition | Straight-line rental expense | Depreciation (asset) + interest (liability) |
| Lessor Accounting | Operating/finance distinction | Largely unchanged |
| Impacted Entities | Mainly with finance leases | Most with any lease, except low-value/short-term |
| Transition | Not relevant | Modified retrospective with impact on retained earnings |
6. Conclusion: Take Action Early
The Section 20 amendments are a significant shift for lessees under FRS 102, bringing UK GAAP closer to international standards, improving transparency but also raising the bar for compliance.
Early planning, clear stakeholder communication, and robust system upgrades are the foundations for successful adoption.
If you’re uncertain how these changes will affect your business or how to start, now’s the right time to consult with your advisers or accounting partners to tailor an implementation plan for your organisation’s specific needs.
Glossary of Abbreviations
| Abbreviation | Full Name |
|---|---|
| FRC | Financial Reporting Council |
| UK GAAP | United Kingdom Generally Accepted Accounting Practice |
| SME | Small and Medium-sized Entity |
| IAS 17 | International Accounting Standard 17 |
| IFRS 16 | International Financial Reporting Standard 16 |
| ROU | Right-of-use (asset) |
| P&L | Profit and Loss |
| IBR | Incremental borrowing rate |
| OBR | Obtainable borrowing rate |
Disclaimer: This blog is intended for general informational and educational purposes only. It does not constitute professional advice or a formal opinion and should not be relied upon as such. Readers are encouraged to seek advice from qualified accounting or legal professionals specific to their circumstances before making any decisions based on the content herein.