Countdown to FRS 102 - Transitioning IN

In this episode of 'That Retail Property Guy,' host Gary Marshall examines new FRS 102 accounting standards set to impact UK and Irish retailers from January 1, 2026, considering the challenges of transitioning existing leases to the new reporting method, the options available for doing so, and the potential impact on annual accounts. For Retailers with Leases, this episode offers valuable insights into preparing for the significant changes ahead. Tune in for practical tips to ensure a smooth and compliant transition.

00:00 Introduction to the Podcast

00:20 upcoming FRS 102

00:44 Challenges with Existing Leases

01:05 Basics of FRS 102

01:55 Impact on Retailers

06:01 Transitioning to FRS 102

06:24 Modified vs. Full Retrospective Application

09:47 Practical Considerations for Retailers

11:44 Conclusion and Suggestions

Never miss an episode! Follow and like That Retail Property Guy on your favourite podcast platform - available on Apple, Spotify, Amazon and more.

Find out more and message us on the podcast website

Go to ThatRetailPropertyGuy for more on Gary Marshall, Smarter Estates and the TRPG podcast. You can also check out the TRPG Blog for reading versions of key episodes. 

For our niche 'Accounts Recoverable in Retail Property' business services, visit SmarterEstates

And find Gary and team on LinkedIn for regular updates and community info!

Transcript

0:00

Hello, and welcome to that Retail Property guy with your host, Gary Marshall. In each podcast episode, we delve into topics relating to the particular overlap between estate management and accounts payable from the perspective of a retailer as tenant. Retailers, are you ready? Welcome to another episode in our miniseries on FRS 1 0 2, the amended accounting standard for the UK and the Republic of Ireland, which kicks in on the 1st of January, 2026, which at the moment as we drop this episode is just a few weeks away. FRS 1 0 2 will impact many retailers with business leases. In this episode, let's discuss one of the most obvious challenges. This new method for reporting lease liabilities becomes effective on a specific date, the 1st of January, 2026. But most retailers will already have loads of business leases, which are already rolling along. They don't all start on the 1st of January, 2026. So how do we handle this? Is it easy? But hang on, before we launch in at the deep end, let's just catch up on the basics. What is FRS 1 0 2? Regular listeners should already be aware that these mandatory accounting changes are coming soon. The amended rules will apply to many businesses, including retailers if they have leases here at that retail property guy. Our obvious focus is shops and buildings. The businesses are retailers as tenants, the new rules set out how a retail tenant will report its lease obligations in its annual accounts. The definition of a lease is not limited to a lease of a shop or a building. It could be for anything a retailer holds on a lease rather than owns outright. So it could include refrigeration equipment, office equipment, delivery vehicles, the director's car, and so much more. Under the current rules, a retailer doesn't have to indicate how many leases they have or what their cumulative commitment to lease rental is. Whatever the rental payments, they can just pass it through the books as an operating expense, just like buying fuel or a sandwich. So anyone on the outside looking at the business's annual accounts might not be able to see if the retailer has overstretched itself on the lease cost front compared to its earning potential. These interested parties could include potential investors or existing shareholders, banks or private lenders, or even the business's own staff all asking the basic question. Can the business's income service, its lease contract obligations, or is it in too deep over its head weighed down by lease obligations, which could possibly sink it. Anybody remember Woolworths or Debenhams or so many more? So the newly amended rules state that a business must report these lease contracts in the annual accounts. Well, there are some exceptions. Maybe really short leases, maybe low value leases, maybe leases with a rent based only on sales turnover. But otherwise, retailers should by now be well down the road to being able to calculate the present value of their business leases. And these calculations will then sit on the balance sheet, actually on both sides of the balance sheet. It'll be an asset that they get to use, but a liability that they have to pay for. Complicated stuff. So here we are watching the clock tick down to the 1st of January, 2026. The stakeholders in any retailer business should already be on the front foot about this. They should already have asked the obvious questions, done the research, probably procured some software to assist because it won't be easy. Retailers shouldn't view this as merely a project for the finance team, it requires data from the estates managers, maybe also the fleet managers and the equipment managers, and of course, the accountants, the compliance specialists, and the FRS experts. Only a multifunctional approach will help deliver a successful rollout, and that requires a ton of time and resource. Hopefully everybody listening now will be smugly thinking. Yep, I'm on that ahead of the curve, all my ducks in a row. Plans made, resource lined up, data verified, systems tested first. Draft prepared and reviewed. Ready for impact. There will be an impact. This is one of the biggest changes in accounting practice in, well in ages. It'll impact EBITDA earnings before interest tax depreciation, and amortization. In the extreme, the new method of accounting could flip a business from seeming successful. By some metric under the old rules to unsuccessful under the new rules or vice versa, because EBITDA will probably go up. It's the other stuff that would bring the final number back down. So let's get back to the main point here, the start date of the first of Jan, and what to do about our existing leases with no disrespect intended, let's set aside the equipment leases and the vehicle leases. Let's focus just on the property leases, the bricks and mortar locations from which a retailer conducts their business. Let's say a retailer has an ongoing lease. It started a few years ago, say the 1st of January, 2023. It has a few years left to run. The objective of FRS 1 0 2 is to calculate what the present value is or will be on the 1st of January, 2026 for the liability of all the future rent payments up to expiry. Let's emphasize that point. It looks at what remains unpaid on the 1st of January, 2026. It doesn't really look back at everything that has been paid out since the lease started in 2023, but it could do if the retailer wanted it to. So let's dive deeper. The activity of shuffling existing leases across to this new accounting method is known as transition. The 1st of January, 2026 is the transition end date. And when transitioning into FRS 1 0 2, retailers have two options. They can choose between modified retrospective application or full retrospective application. See, I told you it was complicated. The modified version would be where a retailer simply, and I use that word, observably, simply calculates the liability of the remaining lease terms and sticks that in the accounts. And then also maybe adds any adjustments if the new reporting outcome seems very different to what they were reporting last year under the old method. That adjustment is a big, clunky thing, but it's a very practical stepping stone from the old method to the new method. But as the retailers financial whiz kids pour over the first draft of what the new accounting method will produce, a bit like a dry run or a dress rehearsal, they might think that there could be an advantage to reporting. All of the existing leases as if the new method had always applied from way back when when those leases were first granted. This is called the full retrospective method. Of course, the new rules didn't apply in 2023, but the retailer could run a calculation, which looked like it did, and compare the outcome with the simpler modified version, and then choose the method which seems the most appropriate or robust, or clear. It's a bit like being given hindsight. But a caution. If the retailer opts to go back through the full retro version, they might be compelled to identify and reassess all the contracts which existed during the period they are revisiting, which might be backdated to the earliest start date of the longest running live lease. This could mean including expired or disposed leases, which are no longer active, but which formed parts of the rich tapestry of their accounts over that long period. So. To quote a phrase, definitely maybe the retro version could be a minefield and a much bigger administrative hurdle as it seeks to rebuild the retailer's previous accounts as if FRS 1 0 2 as amended had always been the rule. But make no mistake, whichever option a retailer chooses if they have business leases, the new version of FRS 1 0 2 will most likely produce a different outcome of their accounts compared to whatever they did last year. That difference might be hefty, easily noticed, perhaps even detrimental to a previously perceived view of success. It can all be explained away with an accounting adjustment in the initial new accounts, but retailers should be ahead of this curve. They should be checking those first drafts under the new rules, spotting the changes, engaging with their stakeholders to explain the comparison or the lack of it between last year's numbers. This year's numbers, no surprises. And since we're focused on leases of buildings, one particular scrutiny could be the recognition of common lease incentives, like rent-free periods or capital contributions from the landlord. We discuss how FRS 1 0 2 handles these incentives in greater detail in another episode. But suffice to say here that the two methods, old and new deal with these in a very different way, which could skew some of the expected results, especially if an incentive was already fully accounted for under the old regime. And then somehow gets reintroduced under the new one. The retailer should be wary of double counting, of over adjusting or of failing to adjust at all. As we mentioned earlier, retailers preparing to transition into the new rules should already be well on track, giving full consideration to the practical matters such as robust data, is it wise to assume or better to check? The underlying details of all the relevant leases must be robust. The start and end dates must be correct. The rent details must be accurate. The rent reviews, or steps or other changes must be verified. Thoughts must be given to any options, whether that's a break option or a renewal option. Details of rent-free periods, capital contributions, and other lease based cost obligations. And don't forget stamp duty must all be identified and accounted for. If this means a thorough review of all the accepted but never verified data in the database, then so be it. Do that now. Compare gap fill, match off, verify back to the original source, like reading the lease itself. Nevermind what someone's long running Excel sheet might say. You need to know absolutely that the data accurately reflects the leasehold liability and any tweaks and adjustments and variations and so on. Like we mentioned earlier, nobody said this was gonna be easy. The basis for reporting lease liabilities and the asset to balance it is complex stuff. The amendments to FRS 1 0 2 are intended to bring it in line with IFRS 16 for international businesses. Retailers who adopted IFRS 16 as a new reporting regime had to learn on their feet. It had never been done before. Competence software was hard to come by. Expertise was scarce. Opinions were varied and mistakes were made, but domestic retailers. Now stepping up to the revised FRS can at least lean on that prior IFRS knowledge, share some of the hard one learnings and rely on software that's now proven and reliable. Now, as always, bear in mind that this podcast isn't advice. It's just a discussion maybe intending to prompt you to ask questions of your trusted advisor. The upcoming changes in FRS standards are the biggest changes in absolutely ages and non-compliance isn't an option. So wherever you are on this journey to FRS compliance, always bear in mind that the value of good advice often outweighs the cost of it, and generally you get what you pay for. Maybe a local tax accountant isn't the best support in this challenging transition. Seek outs. A reliable and experienced practitioner with relevant experience in this sector may be learned from supporting international businesses who've already adopted the international IFRS standard. Get the right advice, get the right outcome. There are more episodes in this mini series about the transition to FRS. Tune in and join the discussion. Thanks for tuning in to that retail property guy. I hope you enjoyed the discussion and found the subject both entertaining and insightful. And if you'd like more info, go to that retail property guy.com Thanks for listening.