The Abolition of Operating Leases for Lessees: Everything You Need To Know

Financial reporting is set to change in January 2026, which will see a radical update of the Financial Reporting Standard 102 (FRS 102), with one of the most notable shifts being the abolition of the operating lease for lessees.

To better understand this change and how it will affect you as an IT-Tech SME (small and medium enterprise) owner, we’ve put together a guide to help you put your best foot forward once the change is implemented.

Understanding Operating Leases for Lessees

The purpose of the operating lease is to allow lessees to record lease payments as an expense on their income statement without noting it on the balance statement as an asset or liability.

Come January 2026, this will no longer be in practice (although there may be rare circumstances where it may still be required) and it is important that you are prepared for this transition.

Why is the Operating Lease Being Abolished?

The purpose of the abolition is to separate the distinction between operating leases and finance leases for lessees, meaning that all leases will be treated as one entity, which will impact how you undergo your financial reporting from 2026 onwards.

The idea is that when it comes to reporting your finances, the removal of the lease distinction will provide a more accurate representation of the company’s financial position, obligations, and resources, which will be particularly relevant to SMEs.

As a SME owner, you may find that this shift dramatically increases your reported assets and liabilities, with lease assets needing to be depreciated, with any asset interest unwinding the discount of the liability. This may incur two separate charges that affect your profit and loss account via the depreciation of lease liability interest and the right-of-use asset.

How Will the Change Impact SMEs?

Naturally, this shift will result in changes on your balance sheet, which previously wouldn’t have been there, but also it speaks to changes in how lease expenses will be represented in your cash flow statement.

Previously, you will have reported them simply as operating expenses. However, as of 2026, you will be required to classify them (or at least a principal portion) as financing outflows, which will reflect any debt repayment.

This change may be challenging for SMEs who uphold contracts that combine lease and service components, so you will need to separate these by highlighting the lease funds and the expense funds (if applicable).

While this abolition may seem frustrating and time-consuming, particularly for SME owners, who will notice this more prominently, ultimately, the payoff will be more transparency in your financial reporting.

How to Prepare for the Transition

Although 2026 may seem a while away, it is important for SMEs to prepare themselves for this shift. To do so, it is important to assess your current and planned leasing contracts and identify areas in which this coming change will impact them. Also, pay attention to leases that may be up for renewal or planned modifications from now until 2026, as these may affect the valuation of the lease asset and liability.

It is advisable that you seek advice and support from accountants and financial advisors to ensure your financial reporting from 2026 onwards will be accurate, transparent, and smooth.

Disclaimer: The information presented in this blog post is accurate to the best of our knowledge and based on the latest available information as of the date of posting, which is 21st December 2023. However, please note that information, laws, regulations, and circumstances can change over time. Therefore, we cannot guarantee the accuracy, completeness, or currency of the information provided. It is always recommended to verify any information independently and consult with relevant professionals or experts for specific advice or updates. The authors and publishers of this blog post shall not be held liable for any errors, omissions, or outdated information, or for any actions taken based on the information provided in this blog post. Readers are encouraged to use their discretion and exercise due diligence in evaluating the accuracy and reliability of the information before making any decisions or taking any actions based on it.