The move will bring UK GAAP (General Accepted Accounting Practice) more closely in line with IFRS 16, meaning many SMEs and non-listed companies will need to start preparing now for the impact on their balance sheets and financial reporting.
Under the new standard, expenditure incurred under lease agreements - such as rent, car leases, or equipment hire - will no longer be recognised directly as an expense in the profit and loss account.
Instead of showing lease payments purely as an expense, you’ll now show the lease as both an asset and a liability on your balance sheet - and then gradually reduce both as you make payments and use the asset.
Business will need to show:
A liability - representing the total future lease payments still owed to the lessor, discounted to today’s value (so it reflects what those payments are worth in present terms)
A Right-of-Use asset - representing the right to use the leased item (for example, an office building, a vehicle, or a piece of equipment) for the remaining lease period
As you make regular lease payments, the amount you owe (the liability) will decrease, and the interest element will be recognised over the life of the lease. The asset itself will then be written down each year through depreciation, which appears as a cost in your profit and loss account.
This marks a fundamental shift in how finance teams account for day-to-day expenditure and manage their internal reporting. The impact will influence tax treatment, valuations, and lender relationships.
Ryan Parkin, Audit Director said: “Capitalising operating leases will significantly change the balance sheet profile of many businesses. Businesses that have historically exceeded the small company thresholds for revenue or employee numbers may now be required to undergo a statutory audit.
“This change is likely to increase the time and resources business owners and finance teams must dedicate to year end processes and businesses will experience higher annual compliance costs.
“This isn’t just a technical shift - it’s a cultural change in how businesses think about leases. Getting it right early will avoid challenges at year end, but there’s no denying this will increase the complexity of everyday accounting and auditing.”
Pam Keogh, Corporate Tax Director said: “From a tax perspective, qualifying costs in respect of the lease will still attract relief however, how that relief is claimed will significantly change given rent will no longer appear within the profit and loss account.”
“Instead, the depreciation and interest costs relating to the lease will generally be deductible for corporation tax purposes.”
“The key challenge is that traditional depreciation is not usually allowable, with capital allowances applying instead and therefore, finance teams will need to distinguish clearly between the two types of depreciation to ensure full relief is available.”
“The tax position in respect of any transitional adjustments will also need to be considered.”
Chris Matthews, Corporate Finance Associate Director, noted the implications for business valuations.
He said: “This shift could have a real impact on valuation models - particularly those based on EBITDA multiples.
“With lease costs reclassified as interest and depreciation, EBITDA figures will rise, potentially giving a misleading impression of profitability.
“For instance, a business paying £1m a year in rent will suddenly appear £1m more profitable at EBITDA level, despite no change in actual performance. Buyers, sellers and advisors will need to look beyond headline figures to understand the true underlying value.”
Preparing for Change
Preparing early - from understanding the technical adjustments to communicating the implications internally and externally - will help ensure a smooth transition.
At Dains, our dedicated advisors are here to provide clarity every day, helping you minimise risk and make confident decisions about your future.
