2026 Key Accounting Changes – No place for leases to hide

The time has come in which most leases will need to be recognised on the balance sheet under FRS 102. The distinction between operating leases (off-balance sheet) and finance leases (balance sheet) leases has effectively been removed for accounting periods starting on or after 1 January 2026.

Previously if a substantial degree of risk and rewards of ownership were not transferred to the lessee, it would be considered an operating lease. A rental expense would be recorded in the profit and loss account, usually on a straight-line basis over the length of the lease.

Now the same lease will need to be recognised on the balance sheet, subject to the exemptions below.

In short, at inception the lease liability will be the present value (PV) of future lease payments over the lease term, discounted at either:

• Discount rate implicit in the lease, if this is readily available
• If the above isn’t readily available, the incremental borrowing rate, being the rate of interest that a lessee would have to pay to borrow the funds needed to obtain a similar asset over a similar term.

The right of use asset comprises the lease liability plus any prepayments and direct costs.

The same exemptions apply as prior to the update. Short term leases under 12 months or leases involving low-value assets are expensed on a straight-line basis through the profit and loss statement. There is discretion as to what constitutes a low-value asset as a threshold isn’t specified in the guidance.

Charities also fall under the umbrella as Charities Statement of Recommended Practise (SORP) 2026 have adopted the changes to the treatment of leases as described above.

For first time appliers, restatement of comparatives is not required on initial application. A ‘modified’ approach has been permitted, where any cumulative effect of applying the amendments is recorded as an adjustment to opening retained earnings on the balance sheet.

WSM’s view

The transition

While early adopters will face less of an uphill battle, the rest of companies reporting under FRS 102 will have the exciting task of getting to grips with right of use assets, lease liabilities, depreciation and interest payments. A useful exercise for companies would be to pre-calculate the impact on their expected 2026 figures, ideally with the support of accountants familiar with IFRS 16.

Other factors, such as rent-free periods, and quarterly/semi-annual payments may add a few layers of complexity, however having a clear understanding of key terms in the lease agreements should make the process smoother.

Impact on other key figures and metrics

Banking covenants – As these leases move onto the balance sheet, gearing ratios will naturally spike. Many lease agreements will have ‘Frozen GAAP’ clauses to lock in accounting principles from inception to a specific date. For those without these clauses they will want to consider how their obligations in the short and long-term are structured to remain in line with their loan covenants.

Reserves –Charities will need to be aware of the effect of leases on their reserves. With the interest expense now added on top of the straight-line depreciation, reported reserves will initially fall faster than under prior operating lease accounting. In addition, now the free reserves are reduced by approximately the present value of all future payments as opposed to the much lower annual lease payment. This may show a different picture of a charity’s health, all due to financial reporting changes. Trustees would have an interest in updating their reserves policy and disclosures to reflect this and provide clarity to stakeholders.