Forthcoming changes to UK Accounting Standards

Following a Periodic Review in March 2024 by the Financial Reporting Council (FRC), an Exposure Draft was issued documenting amendments to the UK Financial Reporting Standard (FRS) 102. These changes are due to impact periods commencing 1 January 2026 (unless early adoption is elected).

There are two standout changes being made, representing potential significant changes to clients’ financial reporting:

• A five-stage revenue recognition model to be used in both FRS 102 and FRS 105 (FRS 105 is the accounting standard applicable to Micro-Sized Entities); and
• A new model of lease accounting for FRS 102

Revenue Recognition

The new revenue recognition model is based on the International Financial Reporting Standard (IFRS) 15, but with some simplifications.

Entities will need to review revenue contracts and apply the five-step model, potentially impacting the timing of revenue recognition for an entity. In particular, entities will need to consider the treatment for contracts that have goods and services included as a bundle (for instance, this is common with phone contracts where you pay a monthly amount to cover the cost of the phone, plus monthly access to calls/texts/data allowance). Other contracts to consider will be those with variable consideration, warranties or significant financing components.

The five steps required are:

1. Identify a contract with a customer
2. Identify the performance obligations within the contract
3. Determine the transaction price
4. Allocate the transaction price to the performance obligations; and
5. Recognise revenue as or when the entity satisfies those obligations

Upon reviewing and applying the five steps above, conclusions will need to be taken on whether revenue can be recognised over time or at a point in time. This may therefore lead to significant changes in the way revenue was recognised previously.

It may also mean amended terms being issued to customers, particularly if it is difficult to identify performance obligations in the contract, the allocation of value to those obligations, or if there isn’t an enforceable right to payment for work completed to date.

Lease Accounting

The changes in the lease accounting apply to lessees and will see an ‘on balance sheet’ approach taken for a lease, which offers the benefits of ownership despite not passing legal title – called Right of Use (ROU) assets. These assets will be capitalised with the corresponding liability recognised at the same point in time. Entities will need to include all operating leases, such as premises and vehicle leases. The only exceptions will be for those of low-value assets and short-term assets (being those with a lease of less than twelve months at commencement).

In calculating the value for the ROU assets, consideration will need to be taken for the present value of the lease liability, lease incentives, estimated costs of restoration and any direct costs or payments pre-lease commencement.

The lease liability will be discounted using an interest rate implicit within the lease or, if not determinable, the borrowing rate the company could obtain in the market.

Opening adjustments will need to be undertaken from 1 January 2026 for ROU assets which are currently in use, with no prior restatement taking place.

The ROU assets will then unwind via a depreciation charge over the remaining term of the lease and the lease liability will be unwound as a result of cash payments, less interest accrued on the lease liability.

More widely, clients will need to consider if these changes have other impacts for them, such as covenants for ongoing debt arrangements in place and if audit limits are impacted. Also, there will be an impact on corporation tax computations in the year of change.

For further support on these changes, please get in touch with your Ensors contact.