Changes to Lease Accounting for Property

The Financial Reporting Council (FRC) made some key changes to UK GAAP on 27 March 2024. As a result, companies involved in the property & construction sector along with landlords are set to face significant changes in how they report their financial information.

The proposed changes don’t come in to effect until 1 January 2026 although early adoption is permitted if all the amendments are adopted simultaneously.

Whilst 1 January 2026 might seem quite far away, you will likely need to collect data, make accounting judgements and implement systems before this date so it’s important to understand the changes now to be prepared.

In this article we look at the key changes surrounding lease accounting, what the amendments mean for businesses and landlords in the sector, and how you can prepare.

The key changes are alignment with IFRS 16: Leases.

Although the amendments primarily focus on updating FRS 102 which is The Financial Reporting Standard applicable in the UK and Republic of Ireland, the changes affect the whole of UK GAAP, including FRS 105, which is applicable to the micro-entities regime.

Currently, all leases are recognised either as finance leases, and recorded on the balance sheet, or as operating leases. Once the amendments are implemented, the distinction between finance and operating leases will disappear, forming a ‘right-of-use’ balance sheet asset subject to depreciation and interest charges.

• Profit recognition will be impacted, with short-term profits potentially increasing as lease expenses will be spread out as depreciation and interest rather than being recorded directly on the profit and loss statement.
• However, future profits may decrease as costs are accounted for over the lease term. Companies will need to consider how this shift could impact tax liabilities, shareholder distributions and banking agreements.
• As a result of leases appearing as both assets and liabilities, gearing ratios will probably rise. This could impact the perception of the financial health of the company and therefore affect investor confidence.
• The capitalisation of leases leads to higher interest charges in the profit and loss statement. Interest cover calculations will need to be reviewed to ensure companies meet interest obligations and comply with financial covenants. It’s essential to review and possibly renegotiate terms with lenders to accommodate the new accounting requirements.

The accounting requirements for landlords will be largely unchanged with the majority of a landlord’s leases continuing to be classified operating leases, with income being recognised on a straight line or other systematic basis.

For any landlords who have property leases classified as a finance lease though, different rules might apply and they might want to take advice.

As a landlord, the new lease accounting model will have an effect on your tenants too, so you may be asked for information such as the unguaranteed residual fair value, your initial direct costs and the fair value of the property. Tenants that wish to use the rate implicit in their property leases for measurement of their property leases will need this information.

It’s crucial to start planning now to adapt your financial reporting to accommodate new lease accounting standards. Contact a member of our expert team today and we’ll support you in your next steps.