The mandatory FRS 102 changes effective from 2026 will drag most operating leases onto the balance sheet, fundamentally altering key financial ratios for UK SMEs. Here's why accountants must stop reacting and start proactively advising clients now to avoid loan covenant breaches and balance sheet shocks.
Let’s be frank: the year 2026 might feel ages away, but for anyone looking at a client’s current balance sheet, the mandatory changes coming via the Periodic Review 2024 Amendments to FRS 102 are a countdown clock you can’t afford to snooze through. This isn’t just an update; it’s a structural realignment, dragging UK GAAP closer to IFRS, and it’s going to turn some familiar financial statements upside down.
For us, the job isn’t just compliance. It’s about being the smart, proactive advisor who spots the iceberg long before the client’s ship hits it. We need to move fast, especially on leases and revenue recognition, because the technical shifts here are commercially explosive.
If you have clients with operating leases that classic scenario where the expense hits the P&L and the liability stays conveniently off the balance sheet tell them to brace themselves.
The new FRS 102 is basically saying, “Nope, not anymore.” We’re moving to a single lessee accounting model that looks a lot like IFRS 16. That means virtually all leases are going to result in the client having to recognise a ‘Right-of-Use’ asset and a corresponding lease liability.
This is where the fun starts (or stops, depending on your perspective).
Gearing Goes Up: That new liability isn’t shy. Companies that previously looked light on debt are going to see a potentially massive increase in reported liabilities. This is the moment a client’s neatly balanced debt-to-equity ratio could go rogue and, critically, breach existing bank covenants.
P&L Gets Front-Loaded: The simple, straight-line operating expense is out. In comes the more complex combination of depreciation on the asset and interest expense on the liability. Result? Higher expenses in the early years of the lease, which could affect perceived profitability when they need it most.
A Retail Example We’ve All Seen
Imagine a successful high-street retailer with 15 stores, all locked into standard five-year operating leases. Today, their books are clean of lease debt. Post-2026, the present value of those remaining lease payments could easily result in millions of pounds of new liabilities suddenly appearing. This isn’t just an accounting headache; it’s a red flag for their bank manager. Our mission? Help them quantify this exposure now and get to the negotiating table with lenders well in advance. No one wants a surprise covenant breach in Q1 2026.
The transition requires more than just running a new calculation. It demands a sophisticated advisory touch. You are no longer just booking journals; you are managing complex commercial risk.
The challenges your clients are facing like the fear of triggering loan covenant breaches or figuring out the tricky tax divergence between the new accounting rules and existing allowances are your golden tickets for providing high-value advice. This is the moment to transform the inevitable compliance requirement into a strategic advantage.
You need to be running a ‘Covenant Health Check’ across your portfolio, actively modelling how the new rules will stress-test their current EBITDA and gearing figures. But before you can model anything, you need the raw material.
This means rolling up your sleeves and helping clients become data detectives. They need a system, right now, to unearth and track every single operating lease agreement the ones hiding in filing cabinets and email inboxes so you can get that initial measurement right. And finally, help them craft the stakeholder communication plan. Management needs to be prepared to explain why their shiny new balance sheet suddenly looks a little more leveraged to shareholders and investors.
The mandatory date of January 1, 2026, isn’t a long way off in accounting terms. The complexity surrounding leases and the revenue model (which, while less dramatic for most, still requires attention) means the time for action is absolutely now. Seize this moment to be the expert who guided your clients safely through the storm.
So, how are you approaching the critical data-gathering phase with clients? Are you leveraging specialist lease software or relying on trusty spreadsheets to identify those ‘hidden’ operating leases?
