Chapter 1: What is FRS 102?

FRS 102 is the comprehensive financial reporting standard developed by the FRC, the body responsible for financial reporting in the UK and the Republic of Ireland. The standard first came into place in 2015 and was designed to bring UK Generally Accepted Accounting Practice (GAAP) for private entities in line with international financial reporting standards.

While some companies operating in the UK and Ireland opt to adhere to International Financial Reporting Standards (IFRS), most use FRS guidelines because the requirements are simpler and less demanding, and they cost less to implement. 

How does FRS 102 compare to other accounting standards?

The requirements in FRS 102 are based on IFRS with some significant adjustments made for use in the UK and Ireland. Over time, FRS 102 has been moving closer to IFRS, although some important differences remain (you can learn more about the individual differences here.) In general, FRS has been designed to require much less disclosure than IFRS. As noted above, FRS 102 is less complex, takes less time to prepare, and is more cost-effective to apply. For example, with FRS 102, unlike IFRS, it is not necessary to restate prior periods when transitioning to the new standards.

Both UK GAAP and IFRS different substantively from US GAAP. At a high level, the fundamental difference is that IFRS is a principles-based standard and US GAAP is a rules-based standard. IFRS provides less detail and leaves more room for interpretation, while US GAAP is arguably more prescriptive and less flexible. 

What are the recent updates to FRS 102?  

FRS guidelines are subject to periodic review at least every five years. The most recent review was completed in March 2024 and includes significant changes meant to bring UK GAAP into closer alignment with IFRS. Private and public businesses using the FRS 102 financial reporting standard that are not adopting IFRS, FRS 101, or FRS 105 must implement the new FRS 102 amendments outlined in the Periodic Review 2024 by January 1, 2026.

The goal of the most recent amendments is to enhance transparency, comparability, and quality of financial reporting, as well as to enhance compatibility with IFRS. Highlights of the amendments include:

• On–balance sheet lease accounting for lessees, aligned to IFRS 16: Leases, but with certain practical exemptions
• A new five-step model for how companies recognize revenue from customer contracts, aligned to IFRS 15
• Updates across various sections of FRS 102, including small entities disclosures, fair value measurement, supplier finance arrangements, share-based payments, income tax, and specialized activities

What are the early adoption provisions for FRS 102?

The effective date for the amendments to FRS 102 is accounting periods beginning on or after January 1, 2026. Early application is permitted, provided that all the amendments are applied at the same time. In most cases, if a company applies the new standards early, they need to disclose that fact to the FRC. 

How will the changes to FRS 102 affect companies?

First, it may be helpful to identify which companies will be affected by the amendments to FRS 102. Publicly traded UK companies are required to adhere to IFRS, so this discussion does not apply to those entities, in most cases.

Large private companies that are not publicly traded may choose to apply IFRS or FRS 102, FRS 101, and FRS 105. Small and medium-sized entities (SMEs) have the option to apply either full IFRS standards or to use the FRS, specifically FRS 102.

With the types of changes being proposed, and the types of businesses that typically use FRS 102, it is likely that SMEs with multiple loans will be most affected. 

Generally, this will include:

• Companies with multiple locations and therefore many office leases
• Companies with significant vehicle fleets
• Construction companies and other entities with long-term leases of large equipment

While these are the companies likely to be most affected, any entity with a lease longer than 12 months will be affected to some degree. 

The Importance of FRS 102 for Financial Reporting

The changes to lease accounting and, to a lesser extent, revenue recognition are likely to have an impact on financial reporting and key financial metrics. For example, as more leases move onto the balance sheet as financing transactions, total assets and total liabilities will increase, while operating expenses will decrease (see Chapter 2 for more detail on the changes to Lease Accounting). Overall, expect changes to EBITDA, debt, and statements of cash flows. 

Downstream, these changes will likely impact debt and pension covenants, as well as remuneration schemes that are linked to specific financial targets. Because these impacts are going to be felt outside the Finance team, it is vital to engage and explain in advance, as early as possible, how the changes to financial reporting will affect other stakeholders.

Chapter 2: Key Changes in Lease Accounting

Overview of FRS 102 Changes

Many have heard the headline for the new FRS 102—leases are coming on balance sheets—but what does that actually mean? 

Under the previous set of rules, operating leases were recognized as an expense on the profit and loss (P&L) statement. Under the new guidance, all leases will be accounted for as financing transactions, as if funds had been borrowed to obtain the use of an asset for a period of time. These lease obligations are recorded on the balance sheet.

A key material determination for Accounting and Finance teams will be whether a given contract represents a lease under the new rules, or whether it is a service that is recorded against the P&L. The definition of “lease” has broadened considerably beyond the obvious items, such as land and vehicles, to include things like IT contracts, service arrangements, and supplier contracts with embedded leases.

The expected benefits of this change are:

• Improved financial information through enhanced transparency
• More relevant details about assets and liabilities that accurately reflect the economics of significant lease arrangements
• Potentially improved access to capital
• Consistency with international accounting principles, enhancing comparability

Lease Exemptions under FRS 102

FRS 102 provides exemptions for leases that are considered either short-term or for which the underlying asset is low value. 

• A short-term lease is a lease with a duration less than 12 months.  
• The general rule for a low value asset is one worth less than £5000 or $5000, determined on an absolute basis with no reference to the value of the lease payments. 

There are additional considerations when applying these criteria to a lease. 

• When determining the term of a lease, the term is not always completely straightforward. For example, a lease could be a rolling one-month contract, but if a company reasonably expects the lease to last more than 12 months, that would not be considered a short-term lease. 
• When valuing the underlying asset, FRS 102 also sets out certain guidelines that supersede the monetary value. The guidelines state that certain assets like vehicles, construction equipment, land, boats, and aircraft do not qualify as low value. Any asset that is subleased also does not qualify. 

Implementation Challenges

The transition to FRS 102 will present a number of challenges for Finance and Accounting teams:

• More qualitative judgments. Companies will have to analyze contracts and make careful material judgments, such as determining which contracts meet the definition of a lease and which leases are exempt.
• Large amounts of data. Meeting the standards will require companies to extract and manage large amounts of data from all of their leasing contracts.
• Complex contract changes. Because leasing arrangements evolve over time, the assumptions that underlie leasing contracts will need to be revisited every year, which will require companies to manage complex changes across hundreds or even thousands of contracts. 
• Stakeholder expectations. Under the new accounting standards, key financial metrics will change. Finance and accounting teams will need to manage the expectations of other stakeholders, who may be affected by the new numbers.

Drilling down on the need for accounting judgments, there will be a need for qualitative assessment around which contracts meet the definition of a lease. For example, a power purchase agreement may appear on the surface to be a straightforward service agreement that should apply directly to the P&L. But what if the agreement contains a number of embedded leases where the company is leasing the right to all of the energy output? 

Finance and Accounting teams should not underestimate the complexity of judgments related to leases. 

Strategies for Compliance

The first step toward compliance with FRS 102 will be to review all leases and contracts that could contain a lease. Once all leases and potential leases are gathered, they need to be evaluated:

1. Determine which contracts count as leases.
2. Calculate the liability for each lease based on the term of lease and payments due. Then discount those future payments and bring them back onto the books as a liability.
3. Because all leases now have right-of-use assets, companies must calculate depreciation of those assets and apply that value to the P&L. 

This new process will require complex judgments. For example, a company may have a 10-year lease for office space, but with a quit clause at Year 5 and a 5-year extension option at Year 10. How many payments should be brought back on the balance sheet as a liability? 

The Importance of Data Management

A big part of tackling this challenge is data management—extracting all of the data out of dozens, hundreds, or even thousands of contracts. This is important during the transition when evaluating all existing contracts and applying the new standards to them. But it is perhaps even more important after the transition as complex changes are managed on an ongoing basis. 

At the beginning of an implementation of new standards, many companies start by building an Excel model. Excel may work during the transition, but often breaks after the first year as complex term changes, payment changes, and recalculation begin to roll in. 

Role of AI in Accelerating Implementation 

Managing leases manually is not only time-consuming, it is also prone to error. AI-driven automation can play a pivotal role in accelerating the transition to the new lease accounting rules for FRS 102. AI-driven automation can easily and quickly import leases, contracts, and other essential files, and then extract key information needed to make key judgments. 

Data extraction is the most common challenge for companies when adopting new lease accounting standards. Optical character recognition (OCR) technology converts images of text into a machine-readable text format. This tool is extremely valuable when managing leases and other contracts. Rather than manually outputting data from a spreadsheet, OCR enables error-free extraction with one click. And once you have extracted data with OCR tagging, it is clearly documented and easily accessible within the audit trail. 

Chapter 3: FRS 102 & Revenue Recognition

Changes to Revenue Recognition Under FRS 102

Previously, FRS 102 contained a relatively light set of guidance on recognizing revenue, which resulted in both flexibility and inconsistency for companies who used the standards. With the new changes, FRS 102 is now more in line with standards like ASC 606 and IFRS 15. 

The expected benefits of adopting the new five-step model are:

• Simplified process for companies to accurately and uniformly account for revenue transactions
• Enhanced reliability and utility of information regarding the nature, amount, and timing of revenue and cash flows from customer contracts
• Potentially improved access to capital
• Consistency with international accounting principles, enhancing comparability

The Five-Step Model

Under FRS 102, revenue recognition is accomplished in five clear steps:

• Step 1 – Identify the contracts that have been made with a customer
• Step 2 – Identify the performance obligations in each contract
• Step 3 – Determine the transaction price
• Step 4 – Allocate the transaction price to the performance obligations in the contract
• Step 5 – Recognise revenue when (or as) the entity satisfies a performance obligation

Step 1: While this seems straightforward, correctly identifying contracts can be challenging. Some contracts may not be enforceable. A contract bundle may need to be combined into one contract for the purpose of revenue recognition.

Step 2: For many companies, a performance obligation will be a new unit of account that must be clearly defined within a contract. This may require collaboration with other stakeholders within the company to ensure that expectations are aligned. 

Step 3: In some cases, pricing may be a simple, single amount, but in other cases there is variability. An additional constraint is that revenue cannot be counted unless it is highly unlikely to be reversed. 

Step 4: Even once you have clearly defined prices and performance obligations, allocating them will likely require careful judgments. 

Step 5: When is a performance obligation truly satisfied? At what point in time has the company transferred control of good or service? The new five-step model means that revenue recognition has moved from a risk-and-reward model to a control model that requires quite a few judgments. 

Challenges in FRS 102 Implementation

As companies reassess their contract terms and how they account for revenue in the context of the five-step model, there will likely be changes in the timing and amount of revenue recognized. The process of assessing the impact may be complex and time-consuming, so it is advisable to begin as early as possible. 

For most companies adopting the five-step model for the first time, the biggest challenge will be the bundling or unbundling of individual elements within a contract. 

As discussed earlier, a single contract may have bundled together a number of goods and services, which now need to be separated into individual performance obligations, and then priced accordingly. In many cases, this is the most difficult challenge associated with the new revenue recognition model. 

On the other end of the contract is the challenge of variable pricing and how best to make an appropriate estimate of price as it relates to the satisfaction of the performance obligations. Variable consideration, contract modifications, discounts and rebates, and other complexities can wreak havoc on revenue estimates. 

Chapter 4: Accelerated Adoption Tools

Lessons from Previous Implementations 

The adoption in years past of standards like IFRS 16 and ASC 84 have provided a wealth of best practices for companies making the transition to the new FRS 102. While every company is unique and will handle the transition somewhat differently, there are some common lessons that can be learned. 

One important element to consider is timing. Some companies will start implementing a year or two ahead of time, working with internal and external parties both to manage the transition and to put a plan in place for operating with the new standards on a Business as Usual (BAU) basis. 

Unfortunately, many companies delay transition. They end up trying to execute an expedited plan while up against a quarterly or annual reporting deadline. Trying to resolve questions about the standards on the last day of a close cycle is certainly not a best practice. 

There is actually no compelling reason to complete a standards adoption initiative in a compressed period of time. A slower, more methodical approach to the transition is more thorough, and costs the same as an expedited approach. 

“The nice thing is that there is a lot of precedent for implementing these new compliance standards and navigating the interplay of the processes and change management—with help from technology and automation,” says Isaac Heller, CEO and Co-Founder of Trullion. 

Role of Advisory Firms

Accounting advisory firms can be an excellent option for companies looking to achieve accelerated compliance with the revised FRS 102. These firms offer lessons based on past experience with a wide range of companies. They have helped many other companies get up to speed and build a process that will be easy to manage over the long term. 

Typically, an advisory firm will begin by hosting in-person or virtual workshops with a company’s Finance team to determine the scope of the project and begin upskilling staff.

They will then follow that with an impact assessment (see Chapter 5 for more detail) to assess the impact of the new standards on the company’s portfolio of contracts. They collaborate closely with their clients on the preparation of accounting papers, quantification of transition adjustments, and the preparation of new disclosures. 

AI-Driven Tools Can Ease the Transition

AI-driven accounting tools can help companies make the transition to FRS 102 in a number of ways. 

AI-powered data extraction saves time and improves data accuracy.

AI uses Optical Character Recognition (OCR) and other tools to efficiently extract key terms and financial information from leases and other contracts. Replacing manual data entry greatly reduces the incidence of human errors, and of course is much faster. Once the data is extracted, AI tools facilitate verification by reviewing the data against predefined rules, ensuring accuracy and compliance.

AI helps manage ongoing contract modification with structured data formatting, seamless uploading and data insights.

AI-extracted data lives in a structured format that is easy to manipulate within accounting systems. All relevant information is accurately captured and readily available for financial reporting and analysis. This means companies can easily manage complex contract changes at scale while lowering the number of errors. 

AI helps manage compliance strategy with real-time disclosure reports. 

AI enables Finance and Accounting teams to manage stakeholder expectations in real time including auditors. AI empowers organizations to understand how the new standards affect financial metrics and obligations downstream from debt, profit, and other important measures of financial performance. Embracing AI in lease management is not just a technological upgrade but a strategic move towards smarter and more effective business operations.

Chapter 5: Practical Steps for Transition

Initial Impact Assessment

The first step for companies planning to adopt the new amendments to FRS 102 is to perform a qualitative and quantitative impact assessment on their current business and financial statements. 

One output of this effort should be a lease model that calculates the impact of the changes to FRS 102 and prepares the required journal entries on an ongoing basis.

Remember that FRS 102 does not only affect revenue and leases. There are a range of changes that will require individual accounting judgments to be made.

Reviewing and revising lease accounting papers/policies and support with the key accounting judgements. What’s the impact going to be on Net debt, interest covering ratio, EBITDA, gearing. 

Accounting System and Process Updates

The adoption of a new set of accounting standards present both a challenge and an opportunity for existing processes and systems. 

In the case of FRS 102, many companies will find their legacy systems are not flexible enough to handle changing lease terms, different types of leases, and other changing regulatory requirements. But these challenges also present an opportunity for companies and accounting firms to upgrade their technological capabilities to something more appropriate for their business. 

Having the right accounting system can save many hours and headaches when transitioning to FRS 102. But the process of selecting a system requires a high level of diligence. Here are some important points to consider when evaluating an accounting system:

Data collection. The process of compliance with FRS 102 will begin with gathering data from various sources such as billing or customer relationship management systems and Excel files from across the company. Oftentimes this data is completely unstructured. AI can help compare and align multiple data systems in real time, saving many hours of manual work. Make sure any accounting solution has a full suite of data collection tools. 

Accounting judgments. Compliance with FRS 102 requires a significant amount of human judgment— Remeasurements with complex leases or sales contracts require a lot of legwork. It’s also important to document accounting papers, judgments and policies as a company moves through the transition, because auditors will expect a clear story about the decisions that Finance teams have made. With its ability to handle large data sets, AI-driven automation can support human judgment, detecting subtle signals that humans may miss, detecting anomalies and boosting accuracy. AI also makes it easier to document every judgment call. Additionally, with AI handling many of the simple rules-based tasks, accounting professionals will gain time and mental capacity to focus on more high-value topics.

Data integrity. While it may seem like table stakes when evaluating an accounting software solution—and indeed, the vast majority of modern solutions have rock solid data security—it is worth bearing in mind that many older or lighter accounting solutions may not have robust data integrity built in. It’s worth digging deeper when evaluating a new system. 

Integration. It goes without saying that Accounting teams need access to data from other parts of the business, such as Sales. Any accounting software solution should be able to seamlessly integrate with other financial systems or databases within an organization. Otherwise, companies will encounter data silos, inefficient workflows, and a higher likelihood of errors as they transition to FRS 102.

Financial Statement Preparation

Financial disclosures will change as companies adopt the new FRS 102 guidelines. 

The balance sheet. With all long-term and high-value leases moving onto the balance sheet, it is most likely going to increase when companies adopt FRS 102. 

Operating profit. With operating leases now considered as financing agreements, operating expenses will decrease and operating profits will increase. 

The cash flow statement. Total cash flow should remain the same, but it will be categorized differently. 

Conclusion

In conclusion, FRS 102 represents a significant step toward aligning UK GAAP with international standards while maintaining its distinct characteristics that suit smaller entities. With the latest amendments, businesses need to be prepared for changes in lease accounting, revenue recognition, and overall financial reporting. The transition will require careful planning, data management, and the implementation of AI-driven tools to navigate the complexities effectively. By adopting these new standards early and strategically, companies can ensure compliance, improve financial transparency, and ultimately enhance operational efficiency. Embracing this evolution will not only meet regulatory requirements but also provide a foundation for long-term financial resilience.