The Financial Reporting Standard (FRS 102) applicable in the UK and the Republic of Ireland is evolving. Whilst amendments are not yet final, when implemented, there is likely to be a significant impact on automotive businesses in relation to Lease accounting.
What are the key changes?
The two key changes being proposed are the introduction of a new model for revenue recognition, and new procedures regarding Lease Accounting.
For both these amendments an implementation period is proposed, with an effective date of accounting periods commencing 1 Jan 2025, i.e., for 31 December 2025 year ends, although there are several reviews and consultations to take place in the interim.
The standard itself is long, and contains a number of complexities around recognition, measurement and disclosure, but here we highlight in basic detail how the changes might affect lease accounting systems for automotive dealerships.
What is the change in lease accounting?
Put simply, this standard requires ALL leases to be brought onto the balance sheet. So where previously only finance leases were on the balance sheet, the standard now requires all operating leases to also be recognised.
The proposed standard does include certain exemptions from this requirement, but only in two instances:
For short-term leases – typically less than one year
For low-value leases – computers, mobile phones etc
Otherwise, all lease obligations, and their respective right-of-use assets, will need to be recognised on the balance sheet.
How is this likely to affect the automotive industry?
Under the old standard, a company would recognise the lease rental costs on a straight-line basis over the term of the lease. However, under the new standard, that treatment and approach would change, with the rental costs being replaced by depreciation from the Right of Use (ROU) asset, and the interest payable on the lease creditor. The impact on your requirements and the business would be:
A need to value the residual life of the lease (e.g., rental property or vehicles)
The recognition of an ROU asset, with an equal and opposite lease creditor on the balance sheet
These changes would then impact net current liabilities and EBITDA of the business, which, in turn, could impact credit ratings and/or debt covenants and have an adverse effect on tax payable.
As stated, this is a very top-level summary of the potential, but significant changes and how they could impact your lease accounting processes. There is a lot of detail and complexity behind the new standard, so please reach out to Steve Preston at steve.preston@armstrongwatson.co.uk to discuss any aspects of the above in greater detail.
