FRS 102 Lease Changes: What They Mean for Your Profit, EBITDA and Bank Covenants

If your business prepares accounts under FRS 102, some of your most familiar numbers are now calculated differently. Nothing changes in how you trade, but your accounts could tell a very different story.

The changes apply to accounting periods beginning on or after 1 January 2026, so for many businesses the first affected year is already under way. The biggest changes concern leases and revenue. This article focuses on the lease changes, which can alter reported profit, EBITDA, debt and the size of your balance sheet, with knock-on effects for bank covenants, tax, bonuses and audit requirements. We will cover the revenue changes in a separate article.

What is FRS 102, and why has it changed?

FRS 102 is the main UK accounting standard for private companies, limited liability partnerships and many other organisations. It is issued by the Financial Reporting Council (FRC). Small companies usually apply a simplified version, Section 1A, which needs fewer disclosures but follows the same core rules. If your accounts are filed at Companies House, they are very likely prepared under FRS 102.

The FRC's latest periodic review brings FRS 102 closer to the international standards on leases and revenue already used by listed groups. The aim is greater transparency, particularly about long-term commitments such as many property leases, which previously sat off the balance sheet.

When do the FRS 102 changes take effect?

The changes are mandatory for accounting periods beginning on or after 1 January 2026, so the date that matters depends on your year end.

• December year ends. Your current year, ending 31 December 2026, is the first under the new rules. The numbers being generated now already count.
• March year ends. Your first affected year began on 1 April 2026 and ends on 31 March 2027. Forecasts and covenant calculations for this year may already need to reflect the change.
• September year ends. Your first affected year begins on 1 October 2026. That leaves very little time to plan the transition calculations.

Which businesses are affected by the FRS 102 changes?

The lease changes apply to every entity reporting under FRS 102, including small companies using Section 1A.

• Private companies and groups. Companies of all sizes are in scope, as are group and subsidiary accounts. Businesses with property, vehicle or equipment leases are likely to feel the greatest impact.
• Limited liability partnerships. LLPs follow the LLP SORP, which is built on FRS 102 and has been updated for the revised standard. Professional practices leasing offices may see a significant increase in reported assets and liabilities.
• Charities. The 2026 Charities SORP applies to periods beginning on or after 1 January 2026 and brings in the revised lease rules. It also adds charity-specific guidance on arrangements such as peppercorn rents.

Micro-entities using FRS 105 are not affected by the lease changes, but businesses near the micro-entity limits should check which standard applies to them.

What are the main FRS 102 changes?

Leases are moving onto the balance sheet

The previous version of FRS 102 split leases into two types. Finance leases, which transfer substantially all the risks and rewards of ownership, were already on the balance sheet, with depreciation and interest charged to profit and loss. Operating leases, typically office rentals, many vehicle leases and equipment hire, stayed off the balance sheet: the rent was simply expensed, and the future commitment appeared only in a note.

The new rules remove this distinction for businesses that lease assets. Almost all leases are now treated much as finance leases were, with a "right-of-use asset" and a matching "lease liability" recognised, and depreciation and interest replacing the rent charge. The impact falls mainly on former operating leases, so a business renting premises or running a leased fleet will see a bigger shift than one using hire purchase style finance.

Short-term leases of twelve months or less and low-value assets can generally still be expensed. Landlords and other lessors continue to classify leases as finance or operating much as before.

The review also made several smaller changes, mainly to disclosures, which are outside the scope of this article.

Will the FRS 102 changes affect my profit, EBITDA and bank covenants?

Your cash flows do not change, but the way your performance and financial position are measured does.

Why EBITDA is likely to rise

Rent on a former operating lease used to reduce EBITDA. It is now replaced by depreciation and interest, which both sit below the EBITDA line, so EBITDA often increases even though nothing about the business has changed.

For example, a business paying £120,000 a year on an office lease with five years left will pay £600,000 in total. The lease liability is the present value of those payments, discounted at the business's borrowing rate, so at a rate of around 6% it would be roughly £500,000. The right-of-use asset starts at the same amount and is depreciated over the five years, at about £100,000 a year, with first-year interest of about £30,000. Over the full five years, depreciation and interest together still add up to the £600,000 of rent; only the timing changes.

EBITDA rises by the full £120,000 a year, while profit before tax may fall slightly in the early years because interest is higher at the start of the lease. These figures are illustrative only and will depend on lease terms, discount rates and the transition method.

Why debt and covenants may look different

Lease liabilities increase reported debt, changing gearing, net debt and net assets. Whether this helps or hurts your covenants depends on your facility agreement. Some contain "frozen GAAP" wording that keeps the old rules, others follow the current standard, and some are unclear. A higher EBITDA can improve some ratios while higher debt worsens others, so covenant headroom that looked comfortable last year may not be now.

"It is only an accounting change" is not a reliable answer for a lender. Banks generally prefer to hear about the impact early rather than discover it in a compliance certificate.

What else could be affected by the new FRS 102 rules?

Several consequences are easily overlooked until the accounts are being finalised.

• Audit exemption. Right-of-use assets increase your balance sheet total, which helps determine company size. A business near the small company thresholds could lose its audit exemption.
• Tax. Corporation tax generally follows the accounts, so changes in timing can affect when tax is paid. Transitional adjustments should be reviewed for tax alongside the accounts, not afterwards.
• Bonuses, earn-outs and valuations. Many incentives, sale agreements and valuations are linked to EBITDA or profit. If they do not specify the accounting basis, the change could lead to unintended outcomes or disputes.

How do I prepare my business for the FRS 102 changes?

Most of the risk can be managed with early, practical preparation.

• Gather your lease agreements. Collect all property, vehicle and equipment leases, including key terms such as break clauses and rent reviews. Separating former operating leases from finance leases gives a quick view of the likely impact.
• Estimate the impact. A high-level calculation of the effect on EBITDA, debt, net assets and profit shows whether the change is significant for you. It can be refined as the year end approaches.
• Review your loan agreements and speak to your bank. Check how covenants are defined and whether they use frozen or current rules. Approaching your lender early, with clear figures, puts you in a far stronger position.
• Update forecasts and management accounts. Internal reporting on the old basis may give a misleading picture of covenant headroom. Aligning it now avoids confusion later.
• Check agreements linked to profit. Review bonus schemes, earn-outs and shareholder agreements. Agreeing the approach in advance can prevent disagreements.

What happens if I leave it until the year end?

By the time the accounts are being prepared, the opportunity to plan has usually passed. Private companies must file accounts within nine months of the year end, and transition work often takes longer than expected. Late filing penalties range from £150 to £1,500 and double if accounts are late two years running.

The commercial risks can be greater. An unexpected covenant breach, even a technical one, may allow a lender to charge fees, reprice the loan or, in serious cases, demand repayment. None of these outcomes is inevitable, but each is easier to manage when spotted early.

How can CrestWell Accountants and Advisors help?

At CrestWell Accountants and Advisors, we help owners, directors, partners and trustees understand what these changes mean in practice. We can review your leases, calculate the transition impact on profit, EBITDA, debt and net assets, check your covenant position and help you prepare for conversations with your lender. We will also flag knock-on effects for tax, audit thresholds and incentives, as part of our year-end accounts and statutory reporting work.

Every business is different, but early advice almost always gives you more options. If your first year under the new rules has started, or starts soon, now is the right time to act.

To discuss how the FRS 102 changes could affect your business, contact CrestWell Accountants and Advisors today. We will give you a clear view of where you stand and a practical plan for what to do next.