Significant changes to FRS 102, the Financial Reporting Standard applicable in the UK and the Republic of Ireland, come into effect for accounting periods beginning on or after 1 January 2026.
The amendments expected to have the most significant impact on the financial statements are the revisions to revenue recognition and lease accounting.
The new model introduces a five-step process for recognising revenue from contracts with customers, which is far more prescriptive than has previously been the case.
The change will require businesses to review their revenue contracts and consider the nature of performance obligations, any variable consideration and the treatment of contracts with bundles of services.
The change will potentially impact the timing of revenue recognition and may also lead to the recognition of additional assets and liabilities, depending on the satisfaction of the performance obligation.
Changes to the accounting system may be required to ensure that processes are sufficiently robust to identify the contract stage of completion, together with the separate performance obligations and the amount of the contract price to be allocated to each.
Under the new requirements, all leased assets are required to be recognised on the balance sheet as a right-of-use asset with a corresponding lease liability. Currently, assets relating to operating leases (where an asset is hired or rented) are not included on the balance sheet. Lease payments, which are currently included in the profit and loss account, will be replaced by the depreciation of the right-of-use asset and a finance charge from the lease liability.
There are some exemptions for low-value assets, such as small office items, and for leases of less than 12 months, but apart from these, all leased assets, such as property, plant and machinery and motor vehicles, will be impacted.
Businesses will therefore need to review the terms of their operating leases and update their accounting systems to comply with the new requirements, and for those with a high number of complex lease agreements, specialised accounting software may be required.
Whilst changes to recognition and measurement principles will not change the operating effectiveness and cash flows of an entity, they will have a direct effect on any financial Key Performance Indicators (KPI’s) that may form part of loan or other funding covenants.
Gross profit margin, net profit margin, Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDA), gearing, quick ratio and earnings per share are just a few of the KPI’s that may be significantly affected by some of the amendments.
It is important, therefore, for businesses to understand the impact the amendments will have on their financial performance and position to seek to renegotiate loan terms and covenants in advance of falling short of any KPI’s, as well as preparing investors for the changes in reported financials that may arise.
Companies may also want to revise the terms of any financial performance-linked bonus schemes or profit-sharing plans to ensure that these are amended as needed.
In addition, the changes to revenue and lease accounting are likely to impact a company’s gross assets, which have the potential to breach company size and audit limits.
In summary, the changes to FRS 102 will have significant and far-reaching consequences for many businesses. Early preparation is key to navigating these changes effectively. Revenue and lease contracts will need to be reviewed, and accounting systems and processes updated to comply with the new requirements. Communication with stakeholders such as investors and creditors will be vital.
At Pierce, our dedicated team is here to provide expert advice and support on how these changes may affect your business. Get in touch with us today.
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