FRS 102: Putting leases back on the menu for hospitality and retail

Changes to FRS 102 come into effect for accounting periods beginning 1 January 2026. Most leases (other than short term leases and low value assets) now need to be recorded on the balance sheet with a right-of-use asset (ROU) and a corresponding lease liability. 

This will have an impact on key financial metrics, assets and liabilities, potentially impacting gearing ratios and covenant compliance. The changes will also impact EBITDA, with the rent expense being replaced with a depreciation and interest charge.  Consequently, this could also have an impact on other metrics or earn-outs.  

Planning ahead is key to managing your stakeholders. 

The Financial Reporting Council (FRC) has issued amendments to FRS 102, aligning UK GAAP more closely with IFRS 16 leases. These changes will bring operating leases, except short term and low value leases onto the balance sheet for lessees, impacting how assets, liabilities and expenses are reported. 

Effective for periods beginning on or after 1 January 2026, these changes will impact EBITDA, loan covenants, investor metrics, and more. Although, there have been some early adopters, our discussions with finance teams suggest most are only looking to address the matter now. 

Under the revised Section 20 of FRS 102, lessees must: 

• Recognise a right-of-use (ROU) asset and a lease liability for most leases 
• Split lease expenses into depreciation and interest, rather than record a single rental expense 

Exemptions from recognising an ROU asset and lease liability are only applied for: 

• Short-term leases (≤12 months) 
• Low-value assets (so building and vehicles would not qualify, for example 

Hospitality and retail businesses typically hold high volumes of property and equipment leases, making them especially exposed. Here’s what to expect: 

• Balance sheet expansion, with leased assets and liabilities increasing, affecting gearing ratios and covenant calculations 
• An EBITDA boost with lease expenses shifting below EBITDA, potentially improving this metric, but not without consequences – for example, on interest cover ratios 
• Operational complexity, and tracking lease terms, discount rates and modifications may require new systems and processes 
• New strategic decisions, including potentially rethinking leasing vs buying, contract structuring, and pricing strategies 

Auditors will be expecting documentation setting out the process and conclusions drawn in determining the impact of these amendments. Along with the detail of the calculation of the impact including supporting data for judgements made.  

Consider a restaurant lease transitioning from the old to the new FRS 102. The lessee is a UK-based restaurant operator under the following terms:  

• A lease term of ten years 
• An annual lease payment of £100,000 (paid at year-end) 
• A discount rate: 5% 
• Initial direct costs incurred by the lessee of £5,000 
• A lease commencement date of 1 January 2026 

Under the old FRS 102, the lease classified as an operating lease. Annual lease payments of £100,000 are expensed directly to profit or loss, and no lease asset or liability is recognised on the balance sheet.

EBITDA is reduced by £100,000 annually.

Now consider the impact of the new reporting rules: 

Initial recognition

• Lease liability: Present value of £100,000 per year for 10 years at 5% = £772,173 
• ROU asset: Lease liability + initial direct costs: £772,173 + £5,000 = £777,173 

Year 1 accounting entries 

• Depreciation of ROU asset (straight-line over 10 years): £777,173 ÷ 10 = £77,717 a year 
• Interest expense on lease liability (Year 1): £772,173 × 5% = £38,609 

Profit or Loss Impact (year 1), expenses

• Depreciation: £77,717 
• Interest expense: £38,609 
• Total expense: £116,326

Compared with the old method, expenses are higher in the early years due to front-loaded interest, but EBITDA improves because lease costs are now below EBITDA. 

Finally, there's the impact on the balance sheet. 

Balance sheet (end of year 1) 

• ROU asset: £777,173 - £77,717 = £699,456 
• Lease liability: £772,173 + £38,609 - £100,000 = £710,782 

The worked example illustrates the expected changes from the switch to new FRS 102: 

• EBITDA improves under the new model 
• Total expense is higher in early years due to interest 
• Balance sheet expands, affecting gearing and covenants 
• Requires discount rate estimation and lease tracking systems