FRS 102 Amendments: What SMEs need to know about lease accounting and Audit thresholds

The proposed amendments to FRS 102, introduced as part of the periodic review and effective for periods beginning on or after 1 January 2026, represent a significant shift –  the adoption of a lease accounting model similar to IFRS 16.

Under this model, lessees will be required to recognise most leases on the balance sheet as Right of Use (ROU) assets, accompanied by a corresponding lease liability.

This change will have a considerable impact that SMEs need to be aware of, particularly in relation to audit. The key areas of focus are the audit process for ROU assets and the implications for audit thresholds.

Auditing of Right of Use Assets

This marks a fundamental change in how Companies account for leases and how these are reflected in the financial statements. Every business will need to review its lease portfolio and, where applicable, separate leases into individual asset and liability components, which will then be depreciated over the lease term.

As such, careful planning and early communication is essential across the following audit considerations:

• Calculation of the asset and liability, factoring in rent-free periods and peppercorn rents.
• Recognition of assets, including impairment assessments, something that is particularly relevant for retail and hospitality sectors.
• Assessment of dilapidation costs at an early stage, as part of lease capitalisation.
• Evaluation of the interest rate estimate used by the client to amortise lease liabilities.

Each of these elements will need to be reviewed with the client, audited, and considered both prior to and during the first year of implementation to ensure a successful transition.

Additional considerations that will affect the audit process will include:

• Presentation of financial statements for a true and fair view, including appropriate disclosures and whether the amendment is best applied prospectively or retrospectively.
• Impact on banking covenants, notably gearing ratios and interest coverage, as well as stakeholder interpretation of revised financial statements.
• Availability of relevant data and documentation, such as lease agreements, to support ROU asset calculations.
• Scope of lease coverage, ensuring all applicable leases are captured, including non-property operating agreements such as IT equipment, vehicle fleets, etc.
• Distinguishing between long term and short term leases, with the latter being excluded, subject to specific criteria being met.

Audit thresholds

For accounting periods commencing after 5 April 2025, audit thresholds for standalone companies will increase to:

• £7.5 million in assets
• £15 million in turnover
• 50 employees

While the requirement to breach two out of three thresholds for two consecutive years remains unchanged, the increase in reported assets due to the ROU amendments may inadvertently push some companies over the threshold.

Careful consideration needs to be given on how the ROU adjustments will affect both company and group balance sheet – particularly for businesses that may not otherwise meet the audit criteria but will now need to gross up assets under the revised standard.

It is also worth noting that ROU adjustments do not need to be reflected in comparative figures, as the change is treated as a prospective adjustment under the transitional rules of the revised FRS 102. However, where this may affect the true and fair view of the financial statements, it should be discussed between the client and the auditors as to whether a retrospective adjustment is best.

Overview

It is strongly recommended that businesses assess the impact of these changes early and engage with their professional advisers at the earliest opportunity – especially where multiple leased assets are involved, such as property or equipment.

“The sooner you understand your exposure and calculate your position, the better equipped you’ll be to make informed decisions and communicate effectively with stakeholders. Reviewing this now will ensure you stay ahead of this seismic change in accounting policies.” – Richard Lane, Audit Director.