Upcoming Amendments To FRS 102 Revenue Recognition And Lease Accounting

The Financial Reporting Council (FRC) has issued significant amendments to FRS 102 and the treatment of revenue recognition and lease accounting. These changes will take effect for accounting periods beginning on or after 1 January 2026, although early adoption is possible.

The main changes bring the standard more in line with international accounting standards IFRS 15 and IFRS 16 in respect of Revenue Recognition and Lease Accounting and this is broken down in more detail below.

Revenue Recognition – The Five-Step Model

The current FRS 102 model for revenue recognition is relatively simple and focuses on the transfer of risks and rewards of ownership to the customer. Under the revised FRS 102, the new five-step model being introduced is more in line with IFRS 15 (Revenue from Contracts with Customers) and applies a more principles-based approach to all contracts with customers regardless of the nature of the goods and services involved.

The five-step model consists of:

1. Identify the contract(s) with a customer
2. Identify the performance obligations in the contract
3. Determine the transaction price
4. Allocate the transaction price to the performance obligations
5. Recognise revenue when (or as) the entity satisfies a performance obligation

This approach focuses on control rather than risk and rewards, so revenue is recognised as control of goods and services passes to the customer.

How may this affect you?

• A more detailed analysis will be required for each contract and its key obligations. For example, an IT company will need to identify the performance obligations between software packages and support services.
• Revenue may be recognised earlier or later than before depending on the performance obligation timing.
• Increased disclosures or changes to accounting policies may be required including revenue recognition method, judgements made using five-step model and disaggregation of revenue.

Practical Impacts of the Five-Step Model

• Identifying Performance Obligations
  Companies must now identify distinct components in a contract, which requires more judgment than before. Goods or services that were previously treated as a single deliverable must be evaluated separately. This is especially challenging for bundled offerings like software with support or installation.

• Allocating the Transaction Price
  The transaction price must be divided among performance obligations based on individual selling prices. Challenges arise when prices are not directly observable, or discounts apply across bundled items. Estimation methods and detailed documentation are often needed.

• Recognising Revenue Over Time
  Revenue must be recognised either over time or at a point in time, depending on when control transfers. For long-term or service contracts, this requires assessing factors like asset control, enforceable rights, and alternative uses. Choosing the right progress measurement method (output vs. input) is crucial.

• Variable Pricing
  Contracts with variable consideration (e.g., discounts, bonuses) require careful estimation. Revenue can only be recognised if it is highly probable the consideration will be received, requiring ongoing reassessment. This may lead to recognition of new contract assets or liabilities.

Lease Accounting

Under the current FRS 102 model for lease accounting, leases are classified as either:

• Operating lease which are off balance sheet, and rent/lease payments are recognised over time through the profit and loss.
• Finance lease which is on the balance sheet shown as an asset and corresponding liability.

FRC believe that operating leases lacks transparency regarding lease obligations therefore there will no longer be an operating lease classification for companies reporting under FRS102.

The changes are as follow:

• The asset will be recognised as a right-of-use asset and lease liability.
• An appropriate discount rate will need to be applied to the lease liability to bring it to its net present value.
• Discount rates are usually either the lessee's incremental borrowing rate (IBR), the explicit rate per lease contract or obtainable borrowing rates (OBR).
• The right-of-use assets are depreciated over the lease term while the lease liabilities are unwound using a selected interest method mentioned in point 3.

There is an exemption for short-term leases (12 months or less) and leases for low-value assets.

How may this affect you?

Key impacts:

• Higher assets (ROU) and liabilities (lease liability) on the balance sheet.
• The recognition of ROU assets will impact a company's gross asset position and consequently its size. This could trigger more stringent reporting requirements, and the company could lose its audit exemption available to small companies
• This can have a significant impact on the company profit and Loss: Depreciation and interest costs replace operating lease expense.
• Effects on keys ratios such as debt to equity and EBITDA.
• Potential impact on covenants and borrowing capacity.
• Companies will need to provide increased disclosures in their financial statements regarding their lease obligations.
• Lease portfolios will need to be reviewed in detail to calculate Net Present Value for lease liabilities.

It is worth noting that the upcoming changes to lease accounting under FRS 102 will not apply to FRS 105 applicable to micro entities. As such, companies that qualify as micro-entities may wish to consider transitioning to FRS 105, to avoid the more stringent recognition and disclosure requirements for leases.

This option may be particularly relevant given that the size thresholds for micro-entity status are increasing for accounting periods beginning on or after 6 April 2025.

* i.e., gross assets

Dixcart will be publishing a more comprehensive and detailed article on this subject at a later date.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.