What Is a Right-of-Use Asset?
A right-of-use (ROU) asset represents a lessee's right to use a leased item for the lease term. It's recognized alongside a matching lease liability the moment a lease begins, replacing the old off-balance-sheet operating lease model.
The right-of-use asset is initially measured at the amount of the lease liability, plus any initial direct costs, prepaid lease payments and estimated restoration costs, minus any lease incentives received.
- 1↓Initial recognitionMeasure the ROU asset as the lease liability plus initial direct costs and prepayments, minus incentives.
- 2↓Subsequent amortizationDepreciate straight-line over the shorter of the lease term and useful life.
- 3↓Interest accretion on liabilityThe lease liability grows by interest expense each period, calculated on the outstanding balance.
- 4Reduction via paymentsCash lease payments reduce the lease liability (partly principal, partly interest).
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Step-by-step worked examples
A lease liability is measured at $103,908. The lessee also pays $2,000 in legal fees (initial direct costs) and receives a $1,500 lease incentive from the lessor, with no prepayments. What is the initial ROU asset?
ROU = Lease liability + IDC + Prepayments − Incentives ROU = 103,908 + 2,000 + 0 − 1,500 = $104,408
The ROU asset above ($104,408) is amortized straight-line over the 5-year lease term with no residual value. What is the annual depreciation?
Annual depreciation = 104,408 / 5 = $20,881.60 ≈ $20,882 per year
After year 1, the ROU asset has been depreciated by $20,882 and the lease liability has accrued $5,195 of interest but been reduced by a $24,000 cash payment (opening liability $103,908). What are the year-end ROU asset and lease liability balances?
ROU asset = 104,408 − 20,882 = $83,526 Lease liability = 103,908 + 5,195 − 24,000 = $85,103 (The two balances start close together but diverge because depreciation is straight-line while interest is front-loaded.)
Flashcards
Quick quiz
Q1.What is included in the initial measurement of a right-of-use asset?
Q2.Lease liability = $100,000, initial direct costs = $2,000, prepayments = $3,000, incentives received = $1,000. What is the ROU asset?
Q3.How is the ROU asset usually subsequently measured?
Q4.Why do the ROU asset and lease liability balances diverge over the lease term?
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Common mistakes
Forgetting to add initial direct costs to the ROU asset. — Correct: Initial direct costs (e.g., legal fees, commissions) are capitalized into the ROU asset, not expensed immediately.
Ignoring lease incentives. — Correct: Incentives received from the lessor reduce the ROU asset's initial carrying amount.
Assuming the ROU asset and lease liability stay equal throughout the lease. — Correct: They start close together but diverge because depreciation is straight-line while interest accrues on a declining liability balance.
Depreciating over the asset's full useful life regardless of the lease term. — Correct: Depreciate over the shorter of the lease term and the useful life, unless ownership transfers at the end of the lease.
FAQ
What is a right-of-use asset?
It's a lessee's recognized right to use a leased asset for the lease term, capitalized on the balance sheet under IFRS 16.
How do you calculate a right-of-use asset?
ROU asset = lease liability + initial direct costs + prepayments − lease incentives received.
What's the difference between a right-of-use asset and a lease liability?
The ROU asset is the capitalized right to use the leased item (an asset); the lease liability is the obligation to make future lease payments (a liability).
How is a right-of-use asset subsequently amortized?
Typically on a straight-line basis over the shorter of the lease term and the asset's useful life, and it's also tested for impairment.