The 2026 FRS 102 changes will put most leases on the balance sheet for the first time. That's the headline. But one area that gets less attention - and often catches finance teams off guard - is the cash flow statement.
The update aligns the UK standard more closely with IFRS 16, requiring most leases to be capitalised. Your actual cash outflows don't change, but where they appear in the accounts does - and that affects reported metrics, covenant calculations, and how stakeholders read your numbers.
Tip: Visit our dedicated guide to learn everything about the FRS 102 lease accounting changes.
1. Most FRS 102 Leases Will Now Be On-Balance Sheet
Under the revised FRS 102, lessees will need to recognise a right-of-use asset and a lease liability for most leases. This marks the end of the straightforward "rent expense" treatment currently applied to operating leases.
Instead, the lease liability is measured as the present value of future lease payments, and the asset is depreciated over the lease term. This is a significant shift for organisations with large property, equipment, or vehicle leases.
While there are exemptions for short-term leases (under 12 months) and low-value assets, most agreements will now require more disclosure, more estimates, and more system support. Lease accounting is no longer just a line item in the expense report - it's now a balance sheet and financing issue.
2. How FRS 102 Lease Payments Affect Your Cash Flow Statement
Currently, lease payments under operating leases appear in operating cash flows - easy, predictable, and fully expensed. Under the new model, that's changing.
When you capitalise leases, you split payments into:
- Principal repayment of the lease liability - goes to Financing Activities
- Interest portion - goes to Operating Activities (or optionally Financing)
So even though you're still paying the same cash out the door, it shows up differently in your accounts:
| Category | Current (FRS 102 Section 20) | Post-change (New FRS 102) |
|---|---|---|
| Lease Payments | Operating cash outflows | Split: Principal (Financing), Interest (Operating) |
| EBITDA impact | Lower | Higher (no lease cost deduction) |
| Operating cash flow | Lower | Higher |
| Financing cash flow | Not impacted | Lease repayment outflows increase |
This change can make your operating performance look stronger, even if your overall cash doesn't change. This can either enhance transparency or cause confusion - depending on how effectively it's communicated to stakeholders.
3. Estimating Lease Terms and Discount Rates Under FRS 102
There are two key lease calculation inputs that will affect your cash flow statement significantly and these inputs require some accounting judgement to determine the right outcome.
First, you'll need to discount future lease payments - typically using your obtainable borrowing rate - and apply it consistently across your lease portfolio. This will affect both the interest expense recognised and the initial value of the right-of-use asset, which will be depreciated over the lease term.
Secondly, you'll also need to assess the lease term, including whether you're reasonably certain to extend or terminate. Small changes in assumptions (like a one-year extension) can significantly change reported figures, such as the interest expense and the lease liability balance.
For many organisations, this will involve:
- More cross-department collaboration (legal, estates, procurement or treasury)
- Centralised lease data tracking
- Justification of assumptions for audit and internal reporting
It's a more judgement-based process than previous lease accounting - so documentation, consistency, and clarity matter more than ever.
4. Transition Options for FRS 102 Leases: What to Consider
Your transition approach doesn't just impact your balance sheet setup - it directly affects how lease-related cash flows appear across your reporting periods.
The updated FRS 102 lease model requires retrospective application from the start of the earliest period presented - but thankfully, it allows for some practical reliefs to make the transition easier.
In practice, this means applying the simplified (modified retrospective) approach, the only transition method available under FRS 102. This avoids restating comparatives, similar in spirit to IFRS 16's modified retrospective method.
This is quicker, less complex, and doesn't involve reworking historical financials. The trade-off? You lose a bit of comparability across periods, which may affect how stakeholders interpret trends year-on-year.
When deciding how to transition, you'll also need to think about:
- Whether to reassess all your existing lease contracts or keep your current classifications;
- How to handle the opening balances for right-of-use assets and lease liabilities; and
- What disclosures are required in your first year of applying the new rules.
Whichever route you take, the decisions you make now will shape how smoothly the change lands with your board, governors, auditors, and other stakeholders. A bit of early planning can make a big difference.
5. Downstream Effects: Covenants, Budgets, and Reporting
The cash flow reclassification described above isn't just an accounting presentation change. It has real consequences for how your organisation is assessed - both internally and externally.
Loan covenants
If your banking facilities reference EBITDA, net debt, or leverage ratios, the new lease treatment will move those numbers. EBITDA goes up (because rent is replaced by depreciation and interest, both below the EBITDA line), but total debt also increases. Depending on how your covenants are drafted, this could push you closer to - or past - a threshold, even though nothing about your cash position has changed. Review your facility agreements now and talk to your lender before the first set of restated results lands on their desk.
Budgets and variance reporting
If your budget was built on the old treatment (rent as an operating expense), your actuals will look materially different once leases are capitalised. Operating costs drop, depreciation and interest increase, and cash flow categories shift. Management packs and board reports will need updated definitions, or you'll spend every reporting cycle explaining why the numbers don't compare.
Stakeholder communication
Boards, governors, funders, and auditors all need to understand the change before they see the numbers. A brief explanation of what moved and why - ideally before the first reporting period under the new rules - prevents confusion and avoids unnecessary questions about performance that hasn't actually changed.
Start Preparing Now
The cash flow statement tends to get less attention than the balance sheet during FRS 102 transition planning. That's a mistake. It's where stakeholders will notice the change first - operating cash flow suddenly looks better, financing outflows appear where they didn't before, and year-on-year comparisons stop making sense without context.
The organisations that handle this smoothly are the ones that prepare early: reviewing covenant definitions, updating budget templates, and briefing stakeholders before the first set of restated numbers arrives. Those that treat it as a compliance exercise and deal with it at year-end will spend far more time answering questions than they would have spent preparing.
