FRS 102: Retailers Need to Act Now!

Preparing for FRS 102: New Financial Reporting Changes for Retailers

 In this episode of 'That Retail Property Guy,' host Gary Marshall discusses the upcoming changes in accounting rules under FRS 102, which will be mandatory from January 1, 2026. These changes significantly impact how lease liabilities must be reported on balance sheets for businesses in the UK and Republic of Ireland. Gary explains the new requirements and stresses the urgency for businesses to talk to their advisors and ensure compliance well before the deadline. The episode serves as a crucial informational resource for retailers looking to navigate these impending financial reporting changes.

 00:00 Introduction and Overview

00:20 Upcoming Changes in Accounting Rules

01:00 Understanding FRS 102

02:21 Impact on Retail Occupiers

04:11 Implementation Challenges and Advice

05:06 Discussion Points for Property Community

06:08 Detailed Considerations for Lease Reporting

12:30 Calculating Lease Liabilities

16:48 Strategic Implications and Final Thoughts

17:48 Conclusion and Call to Action

Other Relevant Episodes

FRED82, IFRS16 and FRS102: How New Regulations on Lease Reporting Impact Retailers' Balance Sheets

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Transcript

0:00

Welcome to that Retail Property guy with your host, Gary Marshall from the perspective of a retailer as tenant sharing stories and insights through Gary's unique lens. We hope you'll be entertained, enlightened, and may be a little inspired. In an earlier episode, see the link in the show notes? We discussed the changes in accounting rules, which are coming soon for any business. That reports under FRS 1 0 2. These changes are mandatory. They kick in with effect from the 1st of January, 2026, and they bring with them big technical challenges for businesses which fall under that reporting umbrella. And as an aside, lots of small businesses who currently work on the basis of limited reporting might just find themselves swept into this. So the right time is now to talk to your accountant, get advice, consider software, and so on. Don't ignore this. Get it checked. First though, a quick clarification for those who don't recognize what FRS 1 0 2 is. It's a financial reporting standard. FRS. It's applicable in the UK and the Republic of Ireland. It's designed to provide clear and unambiguous guidance to businesses on how they should present their financial information to give a true and fair view of their financial position, including their profit and loss statement. In particular, a consultation process called Fred 82 led to some changes which are now law and kick in on the 1st of January, 2026. For businesses that don't already report under the international version known as. I-F-R-S-I-F-R-S was adopted by many businesses more than five years ago. Lots of big international companies use it and have learned a lot about the mechanics and pitfalls of the intended process, which had never been done before. New laws, new guidance, new expectations. These often bring unforeseen challenges. Gray areas, bumps in the road, apparent exceptions and confusing overlaps. So these international businesses have often had to make judgment calls generally overseen by their accountants and auditors about how to deal with their data and the new requirements. But again, to recap, what were those requirements? Well, the biggest impact for retail occupiers who are mostly tenants rather than property owners, is the need to report a picture of their overall total lease liabilities on their balance sheet. If a business is a tenant of a lot of shops and supporting properties, that's a lot of reporting leases that were previously treated as a simple operating arrangement where the rent was paid from the business's revenue and they're never given a second thought. Suddenly became massive items on the corporate balance sheet showing that the tenant had these long-term contractual obligations may be considered like debts or mortgages. Okay, that's a bit generalized. The lease liabilities actually appear on both sides of the balance sheet as liabilities and assets, which is curious and they should balance themselves out, but at least the obligations were now in clear view. It doesn't just apply to property, but anything that's leased trucks, refrigeration equipment, airplanes, the key definition is a right of use asset. And this new picture helps the auditors, investors, shareholders, anyone to understand the true strength of a business. Is it truly profitable or is it failing to cope under the burden of those massive leasehold millstones around its neck? Most likely, it's probably somewhere in the middle. But where would you put your good money into a business that carried more debt or payment obligation than it can handle? So big international business was first to adopt international IFRS, but now the turn has come around for domestic business to adopt the domestic version FRS. And we say adopt like it's a voluntary choice kind of thing. When we actually mean use it, whether you like it or not, mandatory kind of thing. UK-based businesses, which filed their accounts under FRS rules are now facing the challenges of implementing these changes. The sands of time are running quicker than you might think. These new reporting requirements are not a quick something for your accountant to sort out a few days before they file your account. They require complex decisions and calculations based on robust data and sound judgements. But if you fall under the FRS umbrella, make sure you know your plan to adopt this. Do it now, and do it well. There are lots of discussions going on between UK professionals who are relatively new to this, and yet there's lots of experience and advice out there from the international teams who plowed this particular field maybe seven years ago. Lessons learned that can be shared. Topics to be mentioned for discussion, guidance, and suggestions from those who have been there, done it, and got the t-shirt. Which brings me to me as the podcast name suggests, I'm a property guy, not an accountant, but I supported international clients who were early adopters of IFRS 16 and helped with some strategy and judgment calls to make sure the eventual calculated liabilities would stand up to scrutiny. So I'm offering some discussion points for the greater property community. Ponder these, talk to your advisors or your clients if you are the advisor. Make sure these new assumptions will stand up to scrutiny. Don't get caught out. Don't underestimate the technical demands. Do you need new software? Do any of these considerations, impact or possibly change your corporate strategy? Remember, nobody used to pay that much attention to those revenue payments of rents. But from the 1st of January next year, the sum of your business's leasehold obligations will be under the microscope. Bear in mind, this isn't legal advice or professional guidance. These are just ideas for you to check out. An obvious point to start this discussion is. When to start By this, I mean the new rules kick in with effect from the 1st of January, 2026. But what if your lease has already started? What if you're three years into a five year lease? Do you have to calculate the discounted cash flow, present value of all five years or just the remaining years? Talk to your advisors. There could be options for both points of view, whichever best suits your business position. Many retailers made a decision to transition into IFRS 16, meaning that they set their systems to calculate all their remaining lease liabilities from the same fixed date, irrespective of an earlier lease start. The total calculated liability of two years versus five years makes a big difference, especially across multiple leases in a large portfolio. But another question is, when is a lease not a lease? It seems obvious, but this reporting standard is looking for leasehold obligations. But some retailers might take a view, and if so, it should be a consistent view across all the properties in their portfolio that this definition excludes temporary or short-term arrangements. Maybe it excludes annual licenses, weekly tendencies, daily concessions or services. The lease should give beneficial use to a single tenant. It shouldn't be a shared arrangement with multiple beneficiaries, and it should be the cost of using the space, not paying for other services that the landlord might provide that isn't related to the space like catering or gatekeeper security, or anything under the service charge. So maybe not every charge labeled rent is a hundred percent rent. For the purposes of FRS 1 0 2, talk to your advisors. They might suggest splitting a charge into rent and other either by defining the actual amounts or defining a percentage split. So the eventual calculation uses only the lower rent parts. Which reduces the liability appearing on the balance sheet and does length matter. The new rules allow for judgment calls about short leases or low value leases, so a retailer could make a judgment call to calculate their liabilities only for leases with at least six months remaining from the contractual term, or 12 months or 18 months, or 24 months, whatever seems appropriate within the generality of their portfolio. The main guidance would be to be consistent. On this basis, they could disregard for the purposes of calculating liabilities under FR S 1 0 2. Any shorter lease arrangements. Or maybe make the same kind of judgment call about low value leases to disregard anything with a rent less than what? A hundred pounds a year? A thousand pounds a year. Just be consistent and talk to your advisor. And what if your lease is already expired, but you are still trading from the property because you have the right to hold over under the protection of the 1954 Landlord and Tenant Act. Well, technically this holding over isn't a lease at all. At best, it's a periodic tenancy which could fall below your assumed test for short or long leases. So you might conclude consistently, of course, that you don't even bother with an FRS calculation of liability for any lease where you're holding over. A further point when thinking about the remaining lease term tenants should be realistic about break options. If you consider that the point of the new rules is to calculate the overall liability based on the sum of all rent payable to the end of all the leases, you could understand some tenants thinking, Hmm, but my leases contain break options. I'll just assume that we'll exercise every break, so I'm only gonna calculate those liabilities up to the break date, not the actual expiry. I'm reducing my liability by maybe five years or whatever, maybe more in some cases, but is this realistic? The accounting Standards Authority have the right to expect honesty. If the tenant can genuinely show prior evidence that they usually exercise their break options, usually walk away, that they rarely ignore the break, then okay, maybe considering the break date as an appropriate end date for the calculation is both realistic and robust. But if the tenant's own property history indicates that generally they waive the break, they ignore it, they continue in business, they run the lease of full expiry, then they would really have no robust basis to suddenly recognize every break option as the end of days. And what about options to renew? Well, thankfully in the UK property market, these options are not so common as perhaps they are in the US or in Europe. But if a lease contains an option, agreed with the landlord to renew, and the tenant's own history suggests that they would most likely take this option up in order to remain in occupation, then in theory, their calculation should assume that their liability extends to the end of that renewed lease and even beyond it if the lease suggests that the option is renewable. In my opinion, there isn't an obligation to recognize the right to renew that is generally afforded under the 1954 act because that statutory right isn't embedded in the lease. It isn't an option agreed in advance with the landlord. It's a separate matter. Well, that's my view. Talk to your advisors, get their opinion too. But there is an obligation to recognize any reversionary lease that the tenant might already have committed to. To be clear, reversionary leases are a common device where a tenant and landlord agree a new lease that will kick in on the very next day after the current lease expires. They get all the haggling and negotiating out of the way, well in advance, sometimes years in advance. The tenant usually does this to secure a guaranteed longer term sometimes because they want to invest in a new shop fit and they need enough years remaining on the lease to allow them to depreciate that capital injection. Or maybe the moment was right to secure a rent reduction in return for offering the landlord a guaranteed longer cash flow period. Either way, the existence of the follow on lease means that FRS wants to see all the commitment has won Big sum, not just to the expiry of the current lease, but all the way to the expiry of the follow on lease. Again, this is just my view. Talk to your advisors. That's what you're paying them for. Now, these calculations of liability, they're likely to be complicated. It isn't just a matter of multiplying the number of remaining leases by the annual rent. Well, it could be if you want, but that would probably add a large and unnecessary chunk to your balance sheets. Your professional advisors, not Dave, down the pub, would probably recommend that you use a discounted cash flow. Not that complicated as a one-off, but it could be a real challenge if you have many leases and therefore need many calculations. And also if you need to refresh them from time to time because these reporting obligations alive and real time, not do ones, then forget. The tenant needs to know some stuff, or rather, their professional advisor needs to know some stuff. They need accurate data across all the leases. Start date, end date, passing rent, agreed, future rent changes, whether that's up or down, any break dates and whether these would realistically be utilized. The payment frequency of the rent, whether it's monthly or quarterly, and so on, they need to know if the tenant benefits from any incentives provided by the landlord. And maybe this includes capital contributions, perhaps if the landlord gave the tenant a cash incentive to take the lease or offered to indirectly fund the tenant's shop fit. Maybe it includes rent-free periods, which literally impact the obligation to pay rent, but also it could include tangible costs and outgoings, like if the tenant paid SDLT commonly known as stamped duty when they acquired the lease. These transactions would often be amortized in the tenant's accounts, and they need to be evident in the FRS calculation. Well, don't take it from me. Talk to your advisors. See what they say. Then they need to assume a discount rate for the calculation. Now, here's the technical explanation. Very much simplified. Think of this like the interest rate on a loan, but in reverse. It's the assumption of a rate like inflation that reduces the value of a pound over a period of time. It means that a pound now in the hand is worth more than a likely future pound in maybe five years time. This is the discount bit in the definition, discounted cash flow, and they need to be consistent, but not necessarily uniform. The tenant might have differing types of properties in different locations, maybe prime high street shops, maybe some retail park shops, maybe some warehouses, maybe some smart fashionable offices, maybe some secondary, not so fashionable offices. The professional advisor might assume a different discount rate for each type of property, so long as they can justify that and be consistent. Now the actual calculation does a couple of things. On one hand, it acts like a repayment table that you might associate with a loan or a mortgage. The tenant can easily see the remaining liability diminishing with each rent payment until it eventually winds down to zero liability at the end of the lease term. Bear in mind that this is a calculation based on expectations. It doesn't actually know if the tenant pays the rent on time or at all, but it calculates the contractual liability based on what the lease expects them to do. On the other hand, it also produces a total of all the rents due to expiry discounted over the period to expiry. So probably less than the simple sum of years times rent. This total will then appear on the balance sheet, one balance for every lease, all totaling to the tenants overall liability. The sudden change from prior accounting methods when this wasn't required will no doubt be noticeable for many tenant occupiers. In some cases, it will feel like airing dirty laundry in public. It could show a very different perspective of the apparent worth. And notice I didn't say value of a business. An investor, a shareholder, a competitor, might view this new data with interest, compare it to some yardstick, figure their viewer, how robust they think the business really is. Is it very buoyant, easily able to deal with its rental commitments, or maybe less so just about getting by vulnerable to slight changes in any trading environment. And then just when you thought you've got it all covered. Here's one last thought. Rents on property deals drive this stuff. So the smart tenant should be calculation savvy. Say a tenant concludes negotiations on a rent review. Well, that new rent would probably require a fresh calculation. And if the rent goes up, then so will the liability transfer to the balance sheet. It's the rent multiplied by the number of years remaining on the lease subject to that discounted cash flow, of course, and signing up to a new 10 year lease will add a sum loosely based on 10 years rent onto the balance sheet, whereas a new five year lease will add us some half that size. So if keeping the balance sheet healthy is a critical strategic objective, then maybe long leases are no longer the way ahead. Even if they do seem to offer security, maybe reliance on statutory protection under the 1954 Landlord and tenant Act is becoming more important than ever. So let's wrap this up. At the moment of compiling their statutory reporting, the tenant and their accountants need access to the most up-to-date calculations. To properly reflect the true current nature of the tenant's property obligations. It's like a snapshot at a moment in time, but the prudent tenant should already be aware of the likely numbers and the impact of any property deals on those numbers, and should be planning their property deals to best suit their strategy. And all these calculations, well, more than a handful a year can be a real headache, definitely more suited to a spreadsheet than the back of a matchbox. Probably even more suited to a database than a spreadsheet or maybe ai, who's to say, but disregard this new obligation at your peril. The clock to the 1st of January, 2026 is ticking down, so talk to the right professional advisors now. Maybe get together with other retailers in the same boat. Brainstorm some ideas, but don't sit on your hands. Good luck. Thank you for listening to that Retail Property guy. If you enjoyed the show, please consider leaving a review. Your feedback is greatly appreciated. Be sure to like, share and subscribe so you can never miss an episode. For more information, visit that retail property guy.com. Thanks again for tuning in.