Chris Johnson
Partner, External Audit - Professional Services
Key Contacts
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Jamie Carter
Partner, Business Services and Outsourcing
The upcoming changes to FRS 102 revenue and leases will be mandatory for financial periods beginning on or after 1 January 2026. This will be one of the most significant updates to UK GAAP in recent years.
For Professional Services businesses, these changes may have implications for financial reporting, including the timing of recorded profits and, in many cases, the profits available for distribution to partners of LLPs and shareholders of companies. Understanding the practical impact of the new requirements will be crucial to properly prepare for implementation.
We share our reflections on the key aspects that Professional Services entities should be considering now, and insights from our experience with early adopters.
For a broader overview of the changes to the revenue and leasing requirements, a recording of our discussion on the topic can be accessed via our Events and webinars hub.
The revisions to FRS 102’s revenue requirements shift away from "legacy" UK GAAP, which focused on the risks and rewards associated with the provision of a service, towards an approach based on the point at which control of the contracted advice or asset passes to the end user.
Broadly speaking, revenue recognition will now be accounted for using a five-step model:
The key to the above assessment will be the first step: analysing the nature and consistency of your contracts. For Professional Services entities, these contracts will typically take the form of engagement letters setting out the scope of the services to be provided, the fee arrangements, whether time and materials or fixed fee, and the associated payment terms. Entities will need to be careful when assessing whether the criteria in paragraphs 23.7 to 23.11 of Section 23, Revenue from Contracts with Customers, of the revised FRS 102 have been met.
Some of the questions you might be asked in relation to this assessment will likely include:
These questions may be more difficult to answer if there are inconsistencies in obtaining and retaining signed engagement letters. The revised revenue requirements in FRS 102 do not preclude the use of less persuasive forms of evidence like verbal confirmation of a client's acceptance of a contract, but the burden of demonstrating that a contract exists may become more challenging, particularly during an audit. This could increase the risk of revenue being reversed if the criteria set out in paragraph 23.10, are not met, particularly in the transition year and comparative periods.
Similar considerations apply to scope extensions or scope creep, which may now constitute contract modifications under the revised requirements. Businesses will need to assess these arrangements on a case-by-case basis to determine whether they satisfy the relevant recognition criteria.
Teams will have to understand the variety of contract types that exist across the business, including differences by geography and revenue stream. The assessment of revenue recognition patterns may vary where an entity does not have an enforceable right to payment for performance completed to date under a contract, which can be a common feature in certain jurisdictions. As a result, businesses will need to carefully consider the enforceability of contractual rights when applying the revised revenue recognition requirements.
Early adoption experience for the revised FRS 102 and similar experience from those adopting IFRS 15 and IFRS 16 from 2018-19 demonstrates that there is significant challenge to entities identifying the distinct goods and services within their contracts when transitioning to these revised requirements.
This challenge can arise for a number of reasons, including:
Identifying whether elements of a contract represent distinct outputs that the client can benefit from substantially with resources already at their disposal (like workshop and training sessions delivered within the provision of the overall project); or
Whether the contract’s deliverables are highly interrelated, interdependent and parts of a single overall outcome which the customer can only benefit from once control of this has been passed to the customer.
This can require a substantial element of judgment depending on the nature of contracts in place, and can be magnified by the level substantial difference between contracts across the business. We recommend that entities consider the nature of different types of contracts in their assessment, and challenge the terms of these as early as possible.
The identification of distinct services with different revenue recognition patterns may lead to a change in how entities recognise revenue from contracts depending on the section 23.81 “enforceability” conditions.
The “enforceable right to payment for performance completed to date” under 23.81(c) is likely to be the most important condition in supporting an over-time recognition pattern, remaining largely consistent with how most Professional Services businesses currently account for the majority of legal, consulting and advisory revenues in the UK. Professional Services are generally not able to be consumed at the same rate as they are performed, meaning your client will typically benefit only from the control of the end “product” passing to them, and a significant number of the services provided will not necessarily be linked to an underlying asset controlled by your clients.
Supporting the above condition reverts to the question of what proof businesses have of fee enforceability if contracts are inconsistently signed and retained across the business.
Entities may have contracts in place that are contingent on a future event occurring. Under the new requirements, "no win, no fee" and success fee arrangements will require management to apply either the expected value method, which calculates a probability-weighted average of possible outcomes, or the most likely amount method, which selects the single most likely outcome.
This marks a shift in focus from the legacy requirements typically applied by entities under FRS 102. Under the legacy requirements, entities adopted one of two approaches. The first is a binary methodology under paragraph 23.15, where 100% of the revenue is recognised when the contingent matter becomes virtually certain to be resolved in the entity's favour. The second is a portfolio approach under paragraph 23.14, where the entity estimates average success rates using historical data from previous contingency outcomes. This approach is most commonly seen where there are high volumes of similar cases and a demonstrably reliable historical trend.
The updated requirements are significantly more prescriptive so should be considered in detail ahead of transition.
Entities will need to recognise disbursements in the profit and loss account as either gross (full revenue and full costs) or net (recognising at the net value of the margin/mark up/commission, which in many cases will be £nil for a straight passthrough disbursement). A number of entities have asked how these should be considered under the new requirements.
Being clear, the requirements to consider principal vs. agent were always a part of legacy revenue requirements (23.04) and were detailed as part of a guidance area in the standard (23A.37). The revised standard introduces these in a more prominent part of the requirements (23.36 – 23.40).
Assessments of principal vs. agent are expected to follow the indicators given in the above noted areas, which are similar under both the new and old sets of requirements. The indicators of principal on a disbursement are the entity’s assumption of inventory risk, ability to set the pricing of the service and retaining primary responsibility for delivery of the service. Interestingly, the explicit indicator of assumption of credit risk on a disbursement has been removed under the revised requirements. As such, this is a good opportunity for all entities to clearly define their accounting for passthrough costs and potential agency costs, noting that the most prevalent indicator of being a principal in any analysis is still likely to be that of assuming the primary responsibility for delivery of the service.
While there are practical expedients under section 1.65 to support the transition approach to comparatives under these new requirements, these are only as follows:
None of the above preclude the recognition of transition adjustments for projects “in progress” at the transition date, ie 1 January 2026 for a December year end.
It is important to recognise that the entity may have made improvements to address contract inconsistency in the transitional year to 31 December 2026, but these readiness actions will be post-dated against the transition date of 1 January 2026 and so likely not applicable at that date. You may therefore still require a thorough assessment of the contract evidence in place at the transition date, irrespective of any documentation that was put in place throughout the transitional year.
The recognition of leases under the revised standard will be as an on-balance sheet lease liability and corresponding right of use asset, compared to the legacy treatment of disclosing commitments off balance sheet. Calculations in determining the recognition are largely mechanical, but there is judgement in determining the discount rate applied to the future lease cash flows.
Paragraph 20.49 of FRS 102 requires the entity to discount lease cash flows at the interest rate implicit in the lease, or if this is not available, either the incremental borrowing rate (IBR) or obtainable borrowing rate (OBR). The implicit interest rate can be more difficult to obtain, given the need to derive a fair value of the underlying asset being leased.
The IBR and the OBR represent the interest rate that a lessee would have to pay to borrow funds over a similar term to the leased asset, but there are distinct differences between the IBR and the OBR:
| IBR | OBR | |
| Funds | Rate at which funds could be borrowed over a similar term to the leased asset, with similar security… | Rate at which funds could be borrowed over a similar term to the leased asset… |
| What are funds theoretically used for | … to obtain an asset of similar value to the value of the right of use asset in a similar economic environment. | … to reflect the undiscounted value of lease payments to be included in measurement of the lease liability. |
The use of an OBR might be considered by some entities as a suitable alternative if there is access to financing arrangements already in the business, like a Revolving Credit Facility or other financing loan in place as a starting point. This is because using an OBR does not require any asset-specific factors other than having a similar term to the leased asset, unlike the IBR and the implicit interest rate. The OBR does not strictly need to be with an external third party, but any use of an intragroup financing rate would need to be closely mirrored by Arm’s Length rates available on the market from a third party.
Nonetheless, the use of rates from pre-existing finance arrangements to derive an OBR should be supported by thorough documentation of the degree of “matching” of the periods of the lease and loan arrangement, and with how materially consistent the funds under the loan facility are with the future undiscounted lease payments. Management should also give mind to the “recency” of any such loan information and whether this requires refreshing to support the proposed rate used for the lease.
The changes to the revenue and leasing requirements of FRS 102 are imminent and require action if you haven’t started working through the implications. If you would like to discuss any aspect of what we have covered or have related transition questions, then we would be delighted to hear from you. Please contact Chris Johnson, Jamie Carter or Richard Matthews so we can support you further.