What are the changes to operating lease reporting?
For accounting periods beginning on or after 1 January 2026 there will be fundamental changes to the way businesses report operating leases. These changes will have widespread implications for entities preparing financial statements under UK GAAP.
To date, many UK entities have taken advantage of ‘off-balance sheet’ accounting for their operating leases, by simply reporting a lease rental expense in the profit and loss account when payable. Following the new legislation, entities will be required to record a ‘right of use’ asset and a corresponding financial liability on their balance sheet, aligning UK GAAP under FRS102 more closely with IFRS 16 Leases.
Operating lease reporting – how will this impact my entity?
The effect of this change will be significant for many entities, especially those with substantial operating lease arrangements. Key considerations for all entities will be:
- Lease heavy entities can expect to see significant increases in assets and liabilities, affecting key financial ratios such as debt-to-assets and debt-to-EBITDA.
- Increased business assets could push some entities over the thresholds for company size, potentially impacting simplified reporting options or audit requirements.
- The usual ‘rent expense’ will largely be removed from the profit and loss account, being replaced by depreciation of the ‘right of use’ asset and ‘interest’ charges. This will often result in a higher EBITDA as lease costs shift from operating expenses to depreciation and finance costs.
- Entities with loan agreements tied to financial covenants, such as interest cover and debt-to-EBITDA ratios, will need to carefully assess the potential impact of these changes and speak to their lenders early to minimise possible issues.
Changes to operating lease reporting – what do I need to do?
These changes will significantly affect how operating leases are reported, so early preparation will help avoid any last minute surprises. Suggestions on how to best prepare your business are:
- Identify all lease contracts, including those ‘hidden’ within service agreements.
- Review systems and processes as they may need updating to ensure all lease data is captured and maintained for accounting purposes. Detailed information on lease terms, payment schedules, extension options and an appropriate discount rate will be needed to complete an accurate calculation of the right of use asset and lease liability.
- An earlyimpact assessment is strongly advisable where borrowing covenants are in place as it is advisable to highlight any issues to lenders sooner rather than later.
- Carefully consider the impact that any new operating leases may have on your financial statements prior to entering into the contract.
- Regular reassessments are required for indexation and lease terms and modifications. Records must be accessible and kept up to date at all times.
This shift in UK GAAP in respect of operating lease reporting looks to deliver greater transparency by aligning with international standards, but also demands careful preparation. By understanding the changes and planning proactively, businesses can navigate the move effectively and ensure compliance by the effective date. The ICAEW, RPGCC’s regulators, have recently issued guidance on the changes to lease accounting, if you wanted to read more on the topic their briefing note can be found here.
If you would like to talk to a member of our expert team to ensure that you are prepared for the changes to operating lease reporting ahead contact us on 020 7870 9050 or email us at hello@rpgcc.co.uk.
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