Accounting for leases – what this means for Real Estate

On 15 December 2022, the Financial Reporting Council (FRC) issued its consultation for amendments to FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland. While it is only an exposure draft at this stage, the proposals are expected to come into force.

One of the key proposed changes is accounting for the treatment of leases, bringing them more in-line with International Financial Reporting Standards. From a real estate perspective, the accounting impact for landlords will in most instances be the same with the accounting treatment for rental income largely unchanged.

The changes will however be more significant on tenants as it will mean that all leases, subject to certain limited exemptions, will be brought onto the balance sheet as a right of use asset with a corresponding lease liability. It will also affect the reported profit with the removal of the rental charge replacing it with amortisation of the right of use asset, and an additional interest expensive on the lease liability with some of the key impacts:

• while the total effect on profit for the duration of the term will be the same, the timing of charges will change with the cost of renting accelerated in earlier years of a lease than under the existing model
• key financial ratios will be likely to change including the earnings before interest, depreciation and amortisation (EBITDA) and gearing
• this may impact the reporting covenants to lenders, credit ratings and cost of financing.

As tenants review the impact of these changes to them, they may seek to revisit their lease arrangements to restructure the terms in order to minimise any adverse impact from the resulting changes.

View our article which provides further details on the proposed changes.

For further information, please contact Peter Gilligan, or your usual Crowe contact.