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PKF Francis Clark advises Source Galileo on sale of 40MW battery energy storage project
18 February 2025
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Chartered Accountants since 1919
FRS 102 has a major update every three to five years. The next tranche of updates was published at the end of March 2024. These come into effect for periods starting on or after 1 January 2026, unless you choose to apply them early.
There are two big areas of change around leases and revenue recognition. These are based on the equivalent IFRS standards, with appropriate simplifications.
Previously the revenue chapter in FRS 102 has been short and sweet. It has given a general direction and then you are left to get on with it. The new rules are different. This is not just in the detail of what you need to do, but the way in which you approach it.
Under the new rules there is a five-step model that you need to work through, for each type of revenue in your business.
Currently, if you hit a roadblock along the way when recognising revenue, you make a common sense call from a range of potential options. Under the new five-step approach, there will be a right answer.
It will make revenue accounting more consistent, but it will also mean that businesses who have picked a different answer – not the ‘chosen one’ in the new rules – may need to change. Changes could impact the timing of revenue recognition.
Areas most likely to incur changes are where contracts have bundles of goods and services, warranties, payments to be determined later or non-refundable upfront fees.
Ultimately everything we deliver in a contract – each promise – is recognised either at a point in time, or over a period. The final answer may be the same as what you do right now, but you have to follow the process, you need to check the rules and these are many and detailed.
It is important to work through revenue changes as soon as possible and before you share any forecasts for 2026 to determine whether or not they alter the timing of your recognition.
The proposed change to leasing rules bring all leases onto the balance sheet. This will be important to any business with items held under operating leases e.g. vehicles, equipment and, in particular, buildings.
The accounting impact of the changes is that every lease is treated as finance leases are now.
This means you:
As a rule of thumb, the starting value of the asset will ultimately be recognised as depreciation and the remainder of the lease payments will ultimately be recognised as interest.
There are two exceptions to this:
For either of those, you disclose the expense.
We will also need to start watching for ‘embedded leases’. This is where part of a larger contract meets the definition of a lease… “A contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration”.
For example, a contract where you pay for catering services may give you the right to control specific kitchen equipment on your premises throughout the contract. That would quite possibly fall under the new rules – ask your accountant.
Some practicalities to consider:
EBITDA: neither depreciation nor interest on leases forms part of EBITDA, whereas rental payments on operating leases do. Therefore, EBITDA should be positively impacted. However, recognition of the lease liability and asset on the balance sheet – increasing both your assets and liabilities by the same amount – will bring your gearing ratios closer to one, which may impact bank covenants.
Covenants: depending on the definitions in your covenant documentation, it may impact the extent to which you will be able to meet the covenant tests. Of course, that will also depend on what the covenant document says about changes to UK GAAP and the impact on tests. It will also be different if negotiating new covenants during late 2024 and into 2025 that will be tested from 2026, compared to existing covenants.
Bonus or share schemes: if you have a bonus or share schemes driven by EBITDA, you may want to reconsider in light of the changes. Should you and your teams get a bigger bonus just because the accounting rules have changes how profit is reported?
In general, if you plan to share forecasts about your business or set targets for periods under the new rules, it is best to assess the revenue and lease impacts beforehand.
There are a number of other changes that have been proposed, although these are not as significant as those for revenue recognition and leases.
Section 1A accounts: longer list of ‘required’ disclosures
Fair value measurement (new section 2A): FRS 102’s fair value measurement guidance will be more closely aligned to IFRS 13.
Going concern: small changes to the disclosure requirements for going concern basis of accounting.
FRS 105: will include the new revenue rules, but not the new lease rules. If your figures (without putting leases on the balance sheet) fall below micro thresholds, this may be worth considering… as long as you discuss with other interested parties first. Lenders and other large entities are sometimes more comfortable with full FRS 102.
Revenue: there is a choice of restating prior year as normal or restating current year opening balances only.
Leases:
Fair values: don’t need to revisit prior year valuations
Elsewhere: restate prior year unless there are exemptions
2024
2025
2026
2027
There are some key things you need to think about:
We will be providing additional guidance ahead of this timetable, including a focus on revenue in our next round of Finance Director Seminars in November. If you aren’t on our invite list, please do email Ruth Warren to register your interest.