The first set of UK SME accounts for a 31 December 2026 year-end will look different from any year-end you have signed off before. The office lease, the photocopier lease, the company car lease, all of them turn into balance sheet entries. If you have not modelled the impact yet, your gross assets figure is about to grow and so is the conversation you need to have with your bank, your covenants, and the partner who signs your audit waiver.
TL;DR: From 1 January 2026, amended FRS 102 Section 20 replaces the old operating versus finance lease split with a single on-balance-sheet model. Lessees recognise a right-of-use asset and a lease liability for almost every lease. Short-term and low-value leases are exempt. Transition uses the modified retrospective method, so comparatives are not restated. Gross assets will rise, which can affect small-company status and audit exemption.
What changed under FRS 102 in 2026?
The Financial Reporting Council's 2024 periodic review rewrote Section 20 of FRS 102. The amendments are effective for accounting periods beginning on or after 1 January 2026, with early adoption permitted (FRC, Amendments to FRS 102, 2024).
The change scraps the operating versus finance lease distinction for lessees. Almost every lease now sits on the balance sheet as a right-of-use (ROU) asset paired with a lease liability (Grant Thornton, FRS 102 lease changes, 2024). The P&L pattern also shifts: instead of a single straight-line rent charge, you book depreciation on the ROU asset and interest on the lease liability.
This is the most significant change to UK GAAP since the original FRS 102 transition in 2015. ACCA describes it as the largest accounting shift small businesses have faced in over a decade (ACCA, FRS 102 lease changes, 2026).
Which leases come onto the balance sheet?
Almost all of them. Office space, warehouses, retail units, company cars, plant, machinery, photocopiers, IT equipment leased rather than owned. If the contract gives your business the right to control the use of an identified asset for a period in exchange for payment, it is a lease under the new Section 20.
A useful test from our practice: look at the lease commitments note in your last set of accounts, the one that listed your future operating lease payments. Most of those commitments now move onto the balance sheet.
The two exemptions are narrow and you elect them by class of asset. Short-term leases with a term of 12 months or less and no purchase option can stay off the balance sheet. So can leases of low-value assets (PwC, Amendments to FRS 102 lease accounting, 2024).
Short-term and low-value lease exemptions
Short-term is simple. If the lease term at commencement is 12 months or less and there is no option to buy the asset, you can treat it as a rolling expense in the P&L. Watch for renewal options that effectively extend the term beyond 12 months. If renewal is reasonably certain, the lease is not short-term.
Low-value is messier because FRS 102 sets no fixed monetary threshold. The FRC chose not to import IFRS 16's reference to a 5,000 US dollar guideline (Forvis Mazars, FRS 102 lease accounting 2026, 2026). Instead, you make a judgement at the start of each lease, assessed in absolute terms when new.
Examples that typically qualify as low-value: laptops, tablets, small printers, telephones, individual pieces of office furniture. Examples that do not: vehicles, land, buildings, construction equipment, and major production machinery, regardless of how cheap the specific contract looks. Document your judgement at lease inception. It is one of the first things a reviewer will ask about.
How do you calculate the right-of-use asset and lease liability?
Start with the lease liability. It is the present value of the remaining lease payments, discounted at either the rate implicit in the lease (rare to find in practice) or the lessee's obtainable borrowing rate. FRS 102 specifically allows an "obtainable borrowing rate," a simplification compared with IFRS 16's incremental borrowing rate, so SMEs do not need to model a hypothetical secured-loan rate for every contract (Moore UK, FRS 102 changes 2026, 2026).
The right-of-use asset is the lease liability plus any initial direct costs, plus prepaid lease payments, plus an estimate of restoration costs if the lease requires the asset to be reinstated, minus any lease incentives received.
A worked example helps. A five-year office lease of £30,000 a year, no rent escalation, no incentive, no restoration clause. At a 6% obtainable borrowing rate, the lease liability and ROU asset are both around £126,400 at commencement. That is the figure that lands on your balance sheet on day one of the lease.
Will lease accounting push you out of small-company status?
Possibly. The small-company size thresholds increased for accounting periods beginning on or after 6 April 2025 to turnover £15 million, balance sheet total £7.5 million, and 50 employees (Crowe UK, company size thresholds, 2024). The uplift was timed to absorb part of the gross-assets growth from the new lease rules.
But the headroom is finite. A company sitting at £5 million in gross assets with a long-term office lease worth £2.5 million in present value is now at £7.5 million on day one of transition, right on the small-company ceiling. If you breach two of the three thresholds for two consecutive years, you lose small-company status and audit exemption.
What we see most often when we run pre-transition models: companies with long-term London property leases get the biggest jolt, and companies with vehicle fleets get a smaller but still material uplift. Forecasting this before your year-end is the work that needs doing now.
Transition: the modified retrospective method
The standard requires the modified retrospective method. Comparative figures are not restated. Instead, you measure each lease liability at present value of remaining payments at the date of initial application, and you measure the ROU asset either at the same amount as the liability, or as if FRS 102 had always applied (with a cumulative catch-up to retained earnings).
The first approach is simpler and the one most SMEs will use. It avoids the data hunt for historical lease information that may no longer exist in your records.
You will need a one-line transition disclosure note in your first set of amended accounts explaining the policy choice and the adjustment to opening retained earnings (RSM UK, FRS 102 changes for small businesses, 2024). For year-end accounts, this disclosure is non-optional.
What practical steps should you take before your 2026 year-end?
Six things, in order:
- Pull every lease your business has signed. Include subleases of property, leased vehicles, leased equipment, even office printers on managed-service contracts. Many SMEs find leases they had forgotten about.
- Identify the lease term (including reasonably certain extension options) and payment schedule for each one.
- Pick your obtainable borrowing rate. Most SMEs use the rate they would pay on a new term loan today.
- Apply the short-term and low-value exemptions where appropriate. Document the judgement.
- Calculate the day-one ROU asset and lease liability per lease, then aggregate.
- Model the gross-asset impact against your small-company thresholds. If you are close to losing the exemption, talk to your auditor early.
If you also have leased company cars, the capital allowances treatment interacts with the new accounting in ways that need a tax adjustment in your CT computation. Do not assume the accounting deduction matches the tax deduction. For wider UK reporting changes landing alongside the lease rules, see our note on the UK sustainability reporting standards.
Frequently Asked Questions
Does this apply to micro-entities reporting under FRS 105?
No. FRS 105 (the micro-entities standard) is not amended. The lease accounting changes only affect entities reporting under FRS 102 or FRS 101. If your business is a true micro-entity (turnover up to £1m, balance sheet up to £500k, 10 employees or fewer), you can keep the existing simple rent-as-expense treatment.
What if my lease has a break clause?
You include payments up to the break date only if exercising the break is reasonably certain. If you intend to renew rather than break, include payments to the end of the renewal period. The judgement is made at lease commencement and reassessed only when significant events change the expected term.
Do I need to restate prior year comparatives?
No. The modified retrospective method does not require restatement. The adjustment goes through opening retained earnings at the start of the year of transition, and you disclose the policy choice in the notes.
Will this affect my corporation tax bill?
The tax treatment of lease payments is unchanged. HMRC continues to allow a deduction broadly equivalent to the cash rental. You will need to add back the accounting depreciation and interest from your tax computation and instead deduct the lease payments. This is a tax adjustment, not a permanent difference, and it can affect deferred tax for entities that recognise it.
Can I early-adopt for periods before 1 January 2026?
Yes. The FRC permits early adoption, provided you apply all the periodic review amendments together (revenue recognition under the new five-step model also changes). Most SMEs will wait for the mandatory date, but if you are mid-way through a transaction or refinancing where the new presentation helps, early adoption is on the table.
If you want a model of how the new lease rules will land on your 2026 balance sheet before year-end, get in touch. Our accounting team can run your existing lease portfolio through the transition calculations, flag any small-company threshold risk, and draft the disclosure note your auditor will expect.