The most disruptive part of the FRS 102 revisions is not the accounting. It is what the accounting does to numbers that other people rely on.
Bringing leases onto the balance sheet changes reported debt, gearing, EBITDA and interest cover. Those figures appear in banking covenants, earn-out calculations, bonus schemes and management reporting. The accounting entry is mechanical. The consequences are not.
The practical work, in order
Find all the leases. This sounds trivial and it is where most of the effort goes. Property leases are easy to find. Vehicle leases, equipment hire, IT hardware, printers, coffee machines and embedded leases inside service contracts are not. An embedded lease is the one people miss: a contract described as a service that in substance conveys the right to control an identified asset.
Ask procurement, ask each site, and search the purchase ledger for recurring monthly payments to the same supplier. The population is almost always bigger than the property schedule suggests.
Decide on the exemptions. Short-term leases and leases of low-value assets can be kept off balance sheet. Take the exemptions where they are available: applying full treatment to a photocopier is effort spent for no reader benefit. Document the policy and apply it consistently.
Work out the lease term. Not the same as the contractual term. It includes optional extension periods where extension is reasonably certain, and excludes termination periods where termination is reasonably certain. For a property lease with a break clause you have to form a judgement about whether you will break it, and that judgement changes the liability materially.
This is the area auditors challenge most, because it is the easiest place to flatter the numbers.
Determine the discount rate. Rarely the implicit rate, so usually an incremental borrowing rate. It needs to be supportable: your actual cost of secured borrowing over a similar term for a similar asset, adjusted where necessary. A single group-wide rate applied to leases of very different terms is hard to defend.
Calculate, and keep the calculation. A right-of-use asset and a lease liability at commencement, then interest unwinding on the liability and depreciation on the asset. Spreadsheets work for small populations. Beyond twenty or thirty leases, the reconciliation and remeasurement work justifies a tool.
Where it gets awkward
Covenants. The headline issue. If your facility measures leverage as net debt to EBITDA, and lease liabilities now count as debt, your leverage moves. EBITDA also moves, because rent expense is replaced with depreciation and interest below the EBITDA line, which usually improves EBITDA. The two effects work in opposite directions and the net result depends on your lease profile.
Read the covenant definition. Many are drafted on a frozen GAAP basis, meaning they are measured under the standards in force when the facility was signed, in which case nothing changes. Many are not. Find out which you have, and talk to your lender before the year end rather than presenting them with a breach afterwards.
Remeasurement. Leases change. Rent reviews, extensions, terminations, changes in the assessment of whether an option will be exercised. Each triggers a remeasurement, and the population of leases requiring remeasurement in a year is larger than most entities expect.
Disclosure. The notes are more extensive than the old operating lease commitment table. A maturity analysis, the movement in the right-of-use asset, the amounts recognised in profit or loss, and the judgements applied to lease term and discount rate.
Deferred tax. Recognising an asset and a liability with different carrying values from their tax bases creates temporary differences. Straightforward, and regularly forgotten.
What to do now
If you have not started, the sequence is: build the lease population, agree the exemptions policy, form and document the lease term judgements, evidence the discount rate, then calculate.
Do the covenant check first, though. It takes an afternoon, it involves reading one clause, and it is the only part of this exercise where the answer could require a conversation with your bank. Everything else is arithmetic you control.