FRS 102 changes, audit thresholds and what they mean for businesses and lenders

Changes to company size thresholds and lease accounting rules have significant implications for both businesses and lenders.

Company size thresholds were increased from April 2025, meaning many businesses that previously required a statutory audit may now qualify for audit exemption. However, for accounting periods beginning on or after 1 January 2026, changes to FRS 102 require most leases (currently treated as operating leases) to be recognised on the balance sheet, with businesses recognising both a right-of-use asset and a corresponding lease liability.

While the higher thresholds may bring audit exemption within reach for some organisations, the new lease accounting requirements could have the opposite effect, particularly for businesses with significant property, vehicle or equipment leases, where it could lead to a material increase in reported assets and liabilities, despite there being no change in the underlying economics or cash flows of the business.

For lenders and their customers, understanding how these developments interact will be important when assessing future financial reporting obligations and financing arrangements.

Interaction of FRS102 with company size and audit thresholds

The Government increased the thresholds used to determine company size and audit exemption eligibility with effect for financial years beginning on or after 6 April 2025.

A company will generally qualify for audit exemption if it meets at least two of the following criteria:

• Turnover not more than £15 million (previously £10.2 million)
• Gross assets not more than £7.5 million (previously £5.1 million)
• No more than 50 employees on average

In isolation, these higher thresholds mean that many companies that previously required an audit may now qualify for exemption.

However, bringing lease assets onto the balance sheet may increase a company's gross assets sufficiently to push it back over one of the size criteria. As a result, some businesses that might otherwise have expected to become audit exempt could find that the new lease accounting rules mean they continue to require an audit.

Businesses, advisers and lenders will need to carefully consider the combined impact of both changes when assessing future reporting requirements.

Implications for lenders and covenant compliance

The lease accounting changes may also have a significant impact on lending arrangements and covenant calculations.

Many existing facilities and covenant packages were drafted before on-balance-sheet lease accounting was introduced for FRS 102 reporters. Depending on the wording of finance agreements, the recognition of lease liabilities could affect leverage ratios, gearing calculations, net debt measures and other balance sheet-based metrics.

There may also be implications for EBITDA. Under the current accounting treatment, lease costs are generally recognised within operating expenses. Under the revised model, those costs are largely replaced by depreciation and interest charges. As a result, reported EBITDA may increase even though the business has experienced no change in its underlying cash generation or trading performance.

For lenders, this creates a potential need to revisit covenant definitions and assess whether they continue to operate as originally intended. Key areas to consider include:

• Whether lease liabilities are included within definitions of debt or borrowings
• How EBITDA is calculated and whether lease-related adjustments are required
• The impact on leverage, interest cover and net asset covenants
• The operation of any frozen GAAP or accounting-change provisions

Audit exemption may not remove reporting expectations

While some businesses may become audit exempt as a result of the increased thresholds, lenders may still require audited financial statements as part of their information requirements.

Statutory audit exemption will not necessarily remove the commercial expectation for audited accounts where these form part of a lending relationship.

Review the impact of the changes

Given the potential impact on financial reporting, covenant compliance and audit requirements, a review of affected clients and facilities may help avoid unintended consequences and provide sufficient time for any necessary amendments or discussions with stakeholders.