Time to review your operating leases
Most businesses have operating leases on high cost equipment, this might include photocopiers and other office equipment, but also vehicles, plant and even property. These have always been recorded in the profit and loss account.
Items subject to a hire purchase agreement, where the item is owned by your company at the end of the ‘lease’ period, appear in the balance sheet in the same way as capital purchases.
For accounting periods commencing on or after 1st January 2026 any operating lease with more than 12 months on the lease period are now reclassified as leases and right of use assets and are subject to the same rules as hire purchase agreements – and must be listed on the balance sheet as an asset.
There are some exemptions:
- Short-term leases: if the lease period is less than 12 months at the commencement date of the lease with no purchase option. This exemption needs to be consistently applied to each class of asset.
- Low value asset: no threshold given it is up to each business to determine a value they consider low value. Low value assets can be determined on a lease by lease basis. An example would be a mobile phone, laptop, etc.
When it comes to premises, if you have a rolling 12 month rental agreement, that may fall outside the recategorisation, but, if you have a long-term lease agreement for 5 or 10 years, for example, this will be subject to recategorization.
This change in category means an increase to the liabilities on the company balance sheet, which, in turn, increases the company debt or gearing. Where monthly/quarterly management accounts are provided to the bank to satisfy finance there will be covenants attached to the finance provided. It is important to mention to the bank these changes as an increase in debt could cause a breach of covenants.
In addition to the above exemptions, it is worth looking at the lease agreement to see if a lease actually exists. If a lease does not exist there is no need to capitalise the asset.
A contract contains a lease if the contract conveys the right to control the asset for a period of time in exchange for consideration and there needs to be an identified asset being leased. If the lessor has the right to substitute the asset then no identified asset, so no lease.
In terms of looking at the rights to control the asset, if the lessor has restrictions on what the lessee can do with the asset, potentially, the lessee does not have right of control over the asset, again no lease.
It’s good business sense to plan a thorough review of all your lease and hire purchase agreements to ensure your accounts are accurate.
