Introduction
The Financial Reporting Council’s Periodic Review of FRS 102 introduces significant changes to lease accounting for lessees, effective for accounting periods beginning on or after 1 January 2026 . While these changes affect all entities reporting under FRS 102, they are particularly impactful for construction businesses due to the sector’s heavy reliance on leased assets.
Key changes for lessees
Under the revised FRS 102 lease accounting model, the distinction between operating leases and finance leases is removed for lessees. Most leases will now be recognised on the balance sheet as:
- a Right of Use (RoU) asset, and
- a lease liability, measured at the present value of lease payments.
An exemption from this requirement is available for short-term leases (less than 12 months ) and leases of low value assets (considered on an individual asset basis and using application of judgement). This represents a fundamental shift from the previous approach, where many operating leases were kept off balance sheet. Lessor accounting remains largely unchanged.
Why does this matter to businesses in the Construction sector?
Construction companies are typically lease intensive, relying heavily on leased assets to deliver construction contracts efficiently. These commonly include:
- plant and machinery and equipment used in the delivery of projects;
- vehicle fleets,
- site cabins, and temporary buildings,
- offices, yards and storage facilities.
As a result, the revised standard is likely to lead to a significantly larger balance sheet impact for construction businesses compared to other sectors. The increase in recognised assets and liabilities can also have knock on effects for financial ratios and covenant calculations.
Balance sheet and profit and loss impacts
On balance sheet recognition
Leases that were previously treated as operating leases may now be capitalised as tangible assets with the corresponding entry being recognised as a lease liability. This increases both total assets and total liabilities, potentially changing how stakeholders perceive the financial position of the business.
Profit and loss profile
Lease costs will no longer be presented as a single operating expense. Instead, they are split between:
- depreciation of the Right of Use asset, and
- interest on the lease liability.
This results in a front loaded expense profile, with higher total charges in the early years of a lease compared to later periods. FRS 102 does permit an Observable Borrowing Rate (OBR) to be used in the recognition of the lease liability - this must be an observable rate to the construction business.
EBITDA impact
Because depreciation and interest are reported below EBITDA, reported EBITDA will typically increase, even though there is no change to the underlying cash flows of the business. This is because, under the previous model, operating lease expenses were recognised in profit and loss and did not form any adjustment to EBITDA.
This can materially affect performance metrics used internally and externally and may require additional disclosure in the financial statements.
Key construction specific risk areas
Embedded leases
Construction contracts frequently include plant hire embedded within wider service arrangements. Under the revised definition of a lease, some arrangements previously treated as services may now qualify as leases (and vice versa). This makes careful contract review essential to ensure arrangements are appropriately identified and accounted for.
Variable lease payment arrangements
Many plant and equipment leases include elements such as:
- usage based charges,
- excess hour penalties (particularly in relation to over-measure), and
- index linked payments.
Only certain payments are included in the lease liability calculation. This introduces significant judgement and estimation risk, increasing both complexity and the potential for inconsistency if not managed carefully.
Contract length and break clauses
Construction leases often feature:
- short initial terms, and
- extension or termination options linked to project duration.
Assessing whether such options are “reasonably certain” to be exercised is critical, as this judgement directly affects the size of the recognised lease liability and RoU asset.
Banking covenants, bonding and financial metrics
The implications of the revised standard extend beyond accounting:
Increased reported debt may impact gearing ratios, net debt/EBITDA measures and interest cover.
Construction businesses that rely on banking covenants, performance bonds or surety arrangements. Careful consideration and communication on the financial impact of the adjustments noted above in advance of the application on the new standard is vital in ensuring that there are no technical breaches on financial covenants. In some instances, this may necessitate renegotiation of covenant definitions.
Tax, company size and audit implications
Capitalising RoU assets will increase total assets on a company’s balance sheet, which may:
- push companies over Companies Act size thresholds and impact associated exemptions for small and micro companies
- remove eligibility for audit or consolidation exemptions, or
- affect access to certain tax regimes or reliefs.
While the amendments do not change tax law, they can alter the timing of taxable profits, creating additional deferred tax considerations.
Systems, data and implementation challenges
Construction businesses often face practical difficulties when implementing the revised standard, including:
- a high volume of short term leases that are not always readily identified as leases;
- decentralised, site level contract management,
- limited historic data on discount rates and lease terms.
Practical next steps for construction businesses
To prepare for the revised lease accounting requirements, construction businesses should:
- Identify all leases, including embedded and site specific arrangements.
- Model the balance sheet and identify potential covenant impacts early to avoid surprises.
- Review banking agreements and bonding requirements in advance.
- Assess systems and data gaps, particularly in relation to plant hire.
- Prepare stakeholders—including lenders, investors and boards—for changes to key performance indicators.
How can we help?
Please do connect with us to assist you in both implementation of the standards but also seamless integration into your project and financial reporting.
Sign up for expert insights, industry trends, and key updates—delivered straight to you.