For the directors and owners of UK small and medium-sized companies, January 2026 marks the beginning of the most significant overhaul of UK accounting standards since the current framework was introduced in 2015. The Financial Reporting Council's 2024 Periodic Review of FRS 102 — the Financial Reporting Standard applicable in the UK and Republic of Ireland — introduces changes that will affect how most businesses account for leases, how they recognise revenue from contracts with customers, and what information they must include in their statutory accounts.
These are not minor adjustments. For a business that leases its offices, vehicles, or equipment — which describes most SMEs — the new lease accounting model will change the face of the balance sheet fundamentally. For businesses that sell bundled products and services, or that have long-term contracts with customers, the new revenue recognition model may require the deferral of income that was previously recognised upfront. And for businesses reporting under the small company regime — Section 1A of FRS 102 — new mandatory disclosure requirements apply from the first accounting period beginning on or after 1 January 2026.
At CoreAcc Accountants, we have been working with clients since the final standard was published to model what these changes mean for their specific businesses. This guide sets out everything you need to know, with worked examples that illustrate the practical impact and answers to the questions we are hearing most frequently.
Disclaimer: This article is for general information only and reflects UK GAAP as in force for accounting periods beginning on or after 1 January 2026. It does not constitute professional advice. Always seek specific advice for your individual circumstances.
1. Why the FRS 102 Periodic Review Happened
FRS 102 was developed to align UK GAAP with international financial reporting practice while maintaining a simplified, proportionate framework for UK and Irish entities that are not required to use full IFRS. The 2024 Periodic Review — the FRC's structured review of the entire standard — was triggered by the significant changes that had taken place in international accounting since 2015, most notably IFRS 16 on leases and IFRS 15 on revenue from contracts with customers.
The FRC's conclusion was that UK GAAP should be updated to reflect the principles of these international standards, but in a simplified form appropriate for the size and nature of UK SMEs. The result is a revised FRS 102 that borrows the conceptual framework of IFRS 15 and IFRS 16 while retaining practical simplifications that are not available under full IFRS.
For businesses that also have a parent or subsidiary using full IFRS, this convergence has an additional benefit: the conceptual approach to leases and revenue is now consistent across the group, even if the detailed rules differ.
2. The Lease Accounting Revolution: Bringing the Invisible onto the Balance Sheet
This is the change with the most immediate and visible impact for most businesses, and the one that requires the most preparation before the first affected period closes.
What changed and why
Under the previous version of FRS 102, most leases entered into by SMEs were classified as operating leases — the monthly rental or hire cost was simply expensed to the profit and loss account as it was incurred. The leased asset never appeared on the balance sheet. The obligation to make future lease payments was disclosed in a note to the accounts but did not feature as a liability on the balance sheet itself.
This treatment had a significant consequence: it understated the economic obligations of businesses with large lease portfolios. A company leasing its premises and five company cars had substantial committed future cash outflows that were invisible to anyone reading the balance sheet. Lenders and investors who adjusted for this — an analytical technique known as "capitalising operating leases" — produced a very different picture of leverage and financial risk than the published accounts showed.
The revised FRS 102 ends this. For accounting periods beginning on or after 1 January 2026, most leases must be recognised on the balance sheet as a right-of-use asset and a corresponding lease liability.
How the new model works
The right-of-use asset represents the company's economic right to use the leased item for the period of the lease. It is initially measured at the present value of the future lease payments under the lease, plus any initial direct costs and any lease incentives paid upfront.
The lease liability represents the obligation to make those future payments. It is also measured at the present value of the future payments, using the interest rate implicit in the lease — or, if that cannot be readily determined, the lessee's incremental borrowing rate.
After initial recognition, the right-of-use asset is depreciated over the shorter of the lease term and the asset's useful life. The lease liability is reduced as payments are made, but interest accrues on the outstanding balance each period — meaning the profit and loss account charge is split between depreciation on the asset and interest on the liability, rather than a single straight-line rental expense as before.
The exemptions: short-term and low-value leases
Not every lease must be brought onto the balance sheet. Two exemptions are available.
Short-term leases — those with a lease term of twelve months or less at the commencement date — can continue to be expensed as incurred, without recognition of a right-of-use asset and lease liability. This exemption applies on a class-of-asset basis: if you elect it for short-term leases of office equipment, for example, you must apply it consistently to all short-term office equipment leases.
Low-value asset leases can also be expensed as incurred. The threshold for low-value is based on the value of the underlying asset when new — FRS 102 indicates approximately £5,000 as a reference point, though judgement applies. Tablets, laptops, small items of office furniture, and similar items are typically low-value. Commercial vehicles, office suites, and manufacturing equipment are not.
The balance sheet impact
For any business with material leases — a ten-year office lease, a fleet of company cars, equipment on hire purchase — the balance sheet will look materially different from 1 January 2026 onwards.
Both total assets and total liabilities will increase. Net assets may not change significantly, because the right-of-use asset and the lease liability are initially recognised at broadly the same value. But the gross figures change — and this is what affects financial ratios that matter to lenders.
Gearing — the ratio of debt to equity — will increase if the lease liability is treated as debt. Debt to EBITDA ratios will change. Interest cover ratios will be affected because interest on the lease liability appears in the finance charges line rather than in operating costs. These are precisely the metrics that most bank covenant tests are built around.
Worked Example 1: A Five-Year Office Lease
Meridian Consulting Ltd has a five-year lease on its office, with annual rent of £36,000 payable monthly in advance. The incremental borrowing rate is 5%. The lease commenced 1 January 2026.
The present value of the remaining lease payments over five years at 5% is approximately £155,900. On 1 January 2026, Meridian recognises a right-of-use asset of £155,900 and a lease liability of £155,900.
Under the old rules, Meridian's balance sheet showed no reference to this lease. Under the new rules, both sides of the balance sheet have increased by approximately £155,900. If Meridian has a bank covenant requiring net debt to remain below two times EBITDA, this change needs to be discussed with the lender before the year end accounts are prepared — not after.
The profit and loss account charge in year one is no longer simply £36,000 of rent. It is £155,900 divided by 5 years in depreciation (£31,180) plus interest on the liability for the year (approximately £7,795), giving a total charge of approximately £38,975 — slightly higher than the old straight-line rent in the early years of the lease, evening out over time.
3. Revenue Recognition: The New Five-Step Model
The second major change affects how and when revenue is recognised. The revised FRS 102 adopts a five-step model aligned with IFRS 15, which focuses on the transfer of control of goods or services to the customer rather than the older concept of risks and rewards passing between seller and buyer.
The five steps
The five-step framework requires a business to work through the following analysis for every customer contract.
Step one is to identify the contract. A contract must have commercial substance, create enforceable rights and obligations between the parties, and have a sufficiently certain outcome to justify recognising revenue. A signed written agreement is the clearest case, but oral contracts and purchase orders also qualify provided the criteria are met.
Step two is to identify the performance obligations in the contract. A performance obligation is a distinct promise to transfer a good or service to the customer. The key word is "distinct" — a good or service is distinct if the customer can benefit from it on its own, or together with resources that are readily available, and if it is separately identifiable from other promises in the contract. Where a contract bundles multiple distinct goods or services together, each must be treated as a separate performance obligation.
Step three is to determine the transaction price — the amount the business expects to receive in exchange for satisfying the performance obligations. Where the price is fixed, this is straightforward. Where the contract includes variable consideration — bonuses, penalties, price escalation clauses, or refund rights — the expected value of that variability must be estimated and included in the transaction price, subject to the constraint that only amounts where a significant revenue reversal is unlikely should be included.
Step four is to allocate the transaction price to each performance obligation, in proportion to the stand-alone selling price of each obligation. If Obligation A would be sold for £30,000 and Obligation B for £10,000, and the bundled contract is priced at £35,000, then £26,250 is allocated to A and £8,750 to B.
Step five is to recognise revenue when, or as, each performance obligation is satisfied — meaning when control of the relevant good or service transfers to the customer. For goods, this is typically at a point in time — the moment of delivery. For services that are delivered over time, revenue is recognised progressively as the service is provided.
Why this matters in practice
For businesses with straightforward contracts — a product sold and delivered, a one-off service performed on a specific date — the new model produces very similar results to the old rules and the practical impact is limited.
The impact becomes significant in three specific situations.
Where a contract bundles distinct goods and services together, revenue can no longer be recognised in full on delivery of the goods if a distinct service obligation remains unfulfilled. A software company that sells a licence and three years of support must allocate the transaction price between those two obligations and recognise the support revenue over three years rather than recognising everything at the point of sale.
Where a contract includes a significant financing component — for example, a customer paying in advance for goods to be delivered significantly later, or goods delivered now with deferred payment on extended terms — an adjustment must be made to reflect the time value of money.
Where the outcome of a long-term contract was previously recognised on a completion basis — recognising profit only at the end of the contract — the new model may require earlier recognition as performance obligations are satisfied over the contract term.
Worked Example 2: The Bundled Contract
Apex Technology Solutions Ltd sells a server installation package priced at £40,000 to a customer. The package comprises the server hardware (which Apex would sell separately for £30,000) and a two-year maintenance and support contract (which Apex would sell separately for £10,000 per year, or £20,000 for two years).
The total stand-alone selling price of the two distinct obligations is £50,000. The allocation of the £40,000 contract price is therefore £24,000 to the hardware (£40,000 × 30/50) and £16,000 to the two-year support contract (£40,000 × 20/50).
Under the old rules, Apex might have recognised the full £40,000 on delivery and installation of the hardware. Under the new rules, £24,000 is recognised on delivery of the hardware, and £8,000 per year is recognised as the support obligation is performed over two years. The timing difference — £16,000 deferred from year one — affects both reported profit and taxable profit for the year.
4. Section 1A: New Mandatory Disclosures for Small Companies
Companies reporting under the small company regime — Section 1A of FRS 102 — face a third set of changes in the form of enhanced mandatory disclosures. These changes reflect the FRC's view that the reduced disclosure framework previously available under Section 1A did not always provide readers with a sufficiently complete picture of the company's financial position.
Related party transactions
Previously, small companies were required to disclose related party transactions only where they were not conducted under normal market conditions. The revised Section 1A requires disclosure of all material related party transactions, including those conducted on an arm's length basis.
For owner-managed businesses — where director loans, rent paid to a director's personally-owned property, or service agreements with connected parties are common — this change requires more complete disclosure than was previously necessary. Every transaction between the company and a director, significant shareholder, or connected person must be assessed for materiality and, where material, disclosed in the notes.
Going concern
The revised standard requires small companies to include an explicit statement about going concern — a formal assessment of whether the business can continue to operate for at least twelve months from the date the accounts are approved. The statement must describe the basis on which the directors have reached their conclusion, including any material uncertainties they have identified.
For businesses that are comfortably profitable with strong cash generation and no external financing pressure, this statement is straightforward — the directors confirm that there are no material uncertainties and that the going concern basis is appropriate.
Where there are pressures — a bank facility up for renewal, a loss-making period, a major customer that represents a significant proportion of revenue, or covenant pressure arising from the new lease accounting model — the statement must acknowledge and describe these uncertainties. If the directors cannot conclude that the going concern basis is appropriate, the accounts must be prepared on a different basis, which is a significant and consequential disclosure.
Dividends
The revised Section 1A requires small companies to disclose clearly the amounts of dividends declared and paid during the year, and the amounts recommended or declared after the year end but before the accounts are approved.
For many owner-managed businesses, dividends are the primary mechanism of profit extraction. The new disclosure requirement ensures that anyone reading the accounts — a lender, a prospective purchaser, a future investor — can see precisely what has been taken out of the business during the year and what is being proposed.
5. Transition: How to Get From Here to There
For accounting periods beginning on or after 1 January 2026, companies must apply the revised FRS 102 for the first time. The standard provides two transition options.
The full retrospective approach requires restating all comparative figures as if the new standard had always applied. This produces the most complete and comparable financial information but involves the most work — effectively restating the prior year balance sheet and profit and loss account under the new rules.
The modified retrospective approach — which most companies are expected to use — allows the cumulative effect of the changes to be recognised as a single adjustment to opening retained earnings on the first day of the first period of application, without restating the comparative year. The comparative figures for the prior year remain on the old basis, with a disclosure explaining the change and its effect.
Under the modified retrospective approach for leases, a company can also elect to measure the right-of-use asset at its transition date as equal to the lease liability — rather than retrospectively calculating what the asset would have been had the new model always applied. This practical expedient significantly reduces the transition workload for businesses with multiple leases.
For revenue, the modified retrospective approach requires identifying contracts that were not fully complete at the transition date and adjusting opening reserves for any revenue that should be deferred under the new model.
Worked Example 3: The Transition Adjustment
Clearfield Interiors Ltd has a 31 December year end and is applying the revised FRS 102 for the first time in its year ending 31 December 2026. It has three leases: a five-year office lease (commenced January 2024), a fleet of four company cars on three-year leases (commenced various dates in 2024 and 2025), and a photocopier (low-value — exempt).
On 1 January 2026 — the transition date — Clearfield measures the lease liabilities for its office and car leases at the present value of the remaining payments. The combined lease liability is £189,400. It measures the right-of-use assets at the same amount as the lease liabilities (using the practical expedient). The net effect on opening retained earnings is negligible — the two sides broadly cancel.
The balance sheet at 1 January 2026 shows £189,400 of right-of-use assets and £189,400 of lease liabilities that did not appear in the 31 December 2025 balance sheet. The 2025 comparatives in the 2026 accounts are presented on the old basis, with a note explaining the transition approach and the effect of the changes.
6. The Tax Implications of the FRS 102 Changes
The changes to FRS 102 do not directly change the tax rules — Corporation Tax and Income Tax continue to follow the statutory tax rules, not the accounting treatment, in several key areas. However, the accounting changes create important practical tax considerations.
For leases, the tax deduction for lease payments is based on the amounts actually paid under the lease — not on the depreciation of the right-of-use asset or the interest on the lease liability. This means that for most finance leases and operating leases that are now on balance sheet, the tax deduction timing will differ from the accounting charge. This difference gives rise to a deferred tax balance — either a deferred tax asset or liability — that must be recognised in the accounts and will affect the reported tax charge each year.
For revenue, where the new model defers income that was previously recognised upfront, the timing of the Corporation Tax liability may also shift. However, the rules around the tax treatment of deferred revenue under contract accounting are specific and do not simply follow the accounting deferral in all cases. Where a business has material revenue deferrals under the new model, the interaction with the Corporation Tax position should be reviewed with your accountant before the first affected year end.
The going concern disclosures under the revised Section 1A create an indirect tax implication: where a company discloses significant going concern uncertainties, its ability to recognise deferred tax assets — for example, on trading losses carried forward — may be called into question. A deferred tax asset should only be recognised to the extent that it is probable that sufficient future profits will be generated to utilise it.
Frequently Asked Questions
Which businesses are affected by the FRS 102 periodic review changes?
The revised FRS 102 applies to all UK and Irish entities that prepare accounts under UK GAAP — which means the vast majority of UK companies that are not required to use full IFRS. This includes small companies reporting under Section 1A, medium-sized companies using full FRS 102, large private companies, and groups below the IFRS threshold. Listed companies and their subsidiaries within a listed group using EU-adopted IFRS are not affected. Charities and registered social housing providers apply separate standards.
When do the changes take effect?
The revised standard applies to accounting periods beginning on or after 1 January 2026. Early adoption was permitted for accounting periods beginning on or after 1 January 2025. A company with a 31 December year end applies the new rules for the first time in its year ending 31 December 2026. A company with a 31 March year end applies them for the first time in its year ending 31 March 2027.
Do all leases have to go on the balance sheet?
No. Two categories of lease can continue to be expensed as incurred without recognition of a right-of-use asset and lease liability. Short-term leases — those with a lease term of twelve months or less at commencement — are exempt. Low-value asset leases — broadly those where the underlying asset has a value of approximately £5,000 or less when new — are also exempt. Each exemption is available on a class-of-asset basis and must be applied consistently. For most businesses, office premises, vehicles, and significant equipment must be brought onto the balance sheet; tablets, small items of furniture, and similar items need not be.
Will the lease changes breach my bank covenants?
Possibly — and this is the most urgent practical question arising from the lease changes. Because lease liabilities will increase measured financial debt, and because the depreciation and interest charges will change the structure of the profit and loss account, any financial ratio tests built into your banking agreements could be affected. Some tests measure net debt, others measure EBITDA, others measure interest cover — all three could move in the wrong direction under the new lease model. The right response is to review your bank covenant terms now, model how your ratios will change on transition, and have a proactive conversation with your lender before the accounts are finalised — not after they are filed at Companies House.
How does the new revenue model affect my business if I sell simple products?
For businesses with straightforward contracts — a product sold and delivered at a clear price, or a service performed and invoiced on completion — the new five-step model is unlikely to change the timing of revenue recognition materially. The step-by-step framework confirms what common sense already suggests: you recognise revenue when you have delivered what you promised. The significant impacts arise where contracts bundle multiple distinct goods or services, where payment terms include a significant financing component, or where performance extends over time rather than being satisfied at a point of delivery.
What are the new Section 1A disclosure requirements for related party transactions?
Under the revised Section 1A, all material related party transactions must be disclosed — including those conducted on an arm's length or normal market basis. Previously, only transactions not at arm's length required disclosure. For owner-managed businesses, this typically means disclosing director's loans (both ways), rent paid to properties owned personally by directors or connected persons, consultancy or management fees paid to connected companies, and any other transactions where the company and a related party have exchanged something of value. The disclosure must describe the nature of the relationship, the nature of the transaction, the amount, and any amounts outstanding at the year end.
What is a going concern statement and what must it include?
The going concern statement is a formal assessment included in the notes to the accounts confirming that the directors have considered whether the business can continue to operate for at least twelve months from the date the accounts are approved. Under the revised Section 1A, this must be an explicit statement — not simply an implicit assumption embedded in the accounting policies. For a healthy business with strong cash flow and no external pressures, the statement will confirm that the going concern basis is appropriate and that no material uncertainties have been identified. Where there are pressures — financing uncertainty, covenant risk, loss-making performance, or customer concentration risk — those must be described and assessed. The statement should not simply assert that going concern is appropriate without explaining the basis for that conclusion.
Do the FRS 102 changes affect my Corporation Tax bill?
Not directly — Corporation Tax follows the statutory tax rules rather than the accounting treatment in several key areas. For leases, the tax deduction follows the lease payments made, not the accounting depreciation and interest charge. For revenue, the tax timing does not automatically mirror any accounting deferral under the five-step model. However, timing differences between the accounting treatment and the tax treatment create deferred tax balances that affect the reported tax charge in the accounts. Businesses with material leases or significant revenue deferrals should review the deferred tax implications with their accountant before the first affected year end.
What is the modified retrospective transition approach?
The modified retrospective approach is the most commonly used transition method. Rather than restating all prior period figures as if the new standard had always applied, a business records the cumulative effect of the change as a single adjustment to opening retained earnings on the first day of the first affected period — 1 January 2026 for most calendar year companies. The comparative figures remain on the old basis, with a note explaining the transition. For leases, an additional practical expedient allows the right-of-use asset to be measured at the same amount as the lease liability on the transition date, avoiding the need for a full retrospective calculation. This significantly reduces the transition workload for businesses with multiple leases.
Should I adopt early?
Early adoption was permitted for periods beginning on or after 1 January 2025. For most businesses, the answer to whether to adopt early depends on whether the transition workload — particularly the lease calculations — is more manageable now than at the mandatory date, and whether there is an advantage to having the revised balance sheet in place for a particular commercial reason such as a refinancing or a business sale. Most businesses that did not adopt early will apply the standard for the first time in their 2026 year end accounts. If your year end falls before December 2026, you should be working on transition now.
What CoreAcc Accountants Can Help You With
The FRS 102 periodic review changes are technical, but their practical impact is felt in conversations with lenders, in dividend decisions, in how contracts are structured, and in Corporation Tax timing. Getting them right requires a combination of accounting technical knowledge and commercial understanding of your specific business.
At CoreAcc Accountants, we are working with clients across Hertfordshire and North London on every aspect of the transition. Specifically, we can help you with:
Lease impact modelling: Identifying all leases in scope, calculating right-of-use assets and lease liabilities under the new model, and producing a clear picture of how your balance sheet will change on transition.
Bank covenant review: Modelling your financial ratios under the new lease model and identifying whether covenant tests are at risk, so you can have proactive conversations with your lender based on numbers rather than guesswork.
Revenue contract analysis: Reviewing your customer contracts to identify any bundled obligations, variable consideration, or long-term performance commitments that may require a change in when revenue is recognised.
Section 1A disclosure preparation: Ensuring your related party transaction disclosures, going concern statement, and dividend disclosures meet the new requirements from the outset.
Deferred tax calculations: Calculating the deferred tax implications of the new lease and revenue models and ensuring your tax charge is correctly reported.
Transition documentation: Preparing the opening balance adjustments and transition disclosures required in your first set of revised FRS 102 accounts.
The first accounting periods to which the new standard applies are already underway for calendar year companies. The time to prepare is now — not in December when the year end is looming.
Get in Touch
Whether your first affected period has just started or is still a few months away, the transition planning work is the same. Contact CoreAcc Accountants today for a conversation about how the FRS 102 changes affect your specific business.
CoreAcc Accountants is an ACCA-accredited firm of Chartered Certified Accountants based in Borehamwood, Hertfordshire. This article was published in January 2026 and reflects the revised FRS 102 as issued by the Financial Reporting Council following the 2024 Periodic Review, applicable to accounting periods beginning on or after 1 January 2026. It does not constitute professional accounting or tax advice. Always seek specific advice for your individual circumstances.
