91探花

The upcoming changes to FRS 102 represent a significant shift in UK accounting standards. This article will focus on the new lease accounting model and its impact on manufacturing businesses, along with other important changes like the new five-step  model. The revised standard will for lessees eliminate the difference between finance and operating leases, requiring all operating leases (except for short-term leases and leases of low-value assets) to be included on the balance sheet. This brings UK GAAP closer to IFRS and will have wide-ranging implications for financial reporting, particularly the key performance indicator, EBITDA. Understanding and preparing for these changes is crucial for manufacturing businesses.

What impact will the changes to FRS 102 have on lease accounting for manufacturing businesses?

It is common practice for manufacturing businesses to lease a variety of assets, from plant and machinery to the business premises.

Under FRS 102 in its current form, operating leases ie traditional rental agreements are not reflected on the balance sheet. They are typically recorded as rental expenses, which keeps the lease obligations off the company’s balance sheet. However, the revised FRS 102 mandates that all leases, except for short-term leases and leases of low-value assets, must be capitalised.

For manufacturing businesses, which often lease manufacturing and warehouse space, plant and machinery and office buildings, this change may significantly impact the financial statements. This shift means that right-of-use assets and associated liabilities will potentially have a consequential effect on key financial metrics such as leverage ratios and EBITDA, which impacts debt covenants, credit ratings and the tax position.

As property leases usually last for several years, existing arrangements will likely be caught by the changes to FRS 102, despite the effective date being 1 January 2026.

What are the UK GAAP FRS 102 implementation challenges?

Given the complexity and potential impact of these changes, manufacturing businesses should start preparing in advance of the effective date.

For those businesses with a significant portfolio of leases, gathering the required information on existing leases will be critical to an orderly and smooth transition. In addition, data will need to be captured for new leases at the outset. Companies will need to develop robust systems and processes to manage this ongoing compliance.

Considerations for manufacturing business

As businesses gear up for the application of the new FRS 102 standard, several issues require careful attention, including:

• Completeness of documentation – for the calculated adjustments to be accurate and true-to-life, it is imperative that the business can access a complete library of existing lease agreements, which can then be reconciled to lease expenses recognised in the general ledger.
• Identifying a lease agreement – it is not always clear at inception if a contract is,or contains a lease. A contract is, or contains, a lease if there is a right to control the use of an identified asset for a period of time in exchange for consideration. The company should carefully consider whether it truly has the right to obtain substantially all the economic benefits from, direct the use of, and operate the identified asset throughout the period of use. This is an inherently judgemental section of the accounting standard.
• Determining the discount rate – the discount rate used to calculate the present value of future lease payments is crucial but can be complex to determine. Companies must use the interest rate implicit in the lease if readily determinable. If not, they must use either their incremental borrowing rate or their obtainable borrowing rate, which both require an understanding of the company’s creditworthiness and borrowing terms.
• Uncertainty of lease term – where lease agreements include extension and termination options, assessment is required whether these options will be exercised. Under the amended FRS 102 the calculation of the lease liability and right-of-use asset includes consideration of management’s intentions at lease inception. For rolling leases with terms of less than one year, businesses may need to reevaluate whether they can continue to be treated as short-term leases. 

Other changes to FRS 102

In addition to the changes in lease accounting, several other important updates will affect financial reporting under FRS 102.

Another important change will see the alignment of revenue recognition under UK GAAP with IFRS’s comprehensive five-step model.

The change in the revenue recognition model is likely to be a challenge that will require careful consideration of a company’s contracts with their customers, regardless of whether the contracts are written, oral or implied. These changes will be of particular concern for manufacturing businesses who, for example:

• Manufacture goods to customer specifications – an entity may currently recognise the sale of customised goods at a point in time, it can’t be presumed that this will simply continue under the revised FRS 102.
• Offer their distributors a right of return or the ability to hold consignment stock
• Have contracts with variable elements – variability may exist in the consideration to be paid by the customer, for example due to volume bonuses or rebates.
• Engage in long-term contracts – long-term can be viewed as any contract which stretches over 12 months.

There will also be enhancements in fair value measurement, changes in the accounting for business combinations, expanded disclosures for supplier financing arrangements, guidance on uncertain tax positions, and updates to the accounting for share-based payments. It is crucial for businesses to not only prepare for the major changes in lease and revenue accounting but also to stay informed and ready for these additional modifications to FRS 102.

How we can help

We have a dedicated team of accounting and financial reporting experts experienced in accounting for the new revenue and leasing requirements, together with other changes to FRS 102.

We can help you understand the impact of the amended standards on your management information, financial statements, and business operations, providing practical guidance on how to implement them effectively and efficiently.

We can also help you plan your communications with your stakeholders and ensure that your financial statements are clear, transparent, and compliant with the new requirements.

If you require any support or would like to discuss financial reporting for your manufacturing markets in more detail, please contact Danielle Stewart OBE.