Right-of-Use Assets: A Comprehensive Guide for Businesses

Lease accounting standards have significantly changed in recent years, resulting in new rules and calculations for right-of-use (ROU) assets and lease liabilities. Lessees and lessors must familiarize themselves with these updated guidelines to maintain regulatory compliance. This article provides a concise overview of the essential concepts of right-of-use assets and lease liabilities, including their respective calculations under various lease accounting standards such as ASC 842, IFRS 16, and GASB 87.

Applying these new lease accounting standards will enable you to better manage your financial statements and make well-informed decisions. The subsequent sections will delve into specifics, such as ROU asset amortization and the impact of these assets and liabilities on the balance sheet, offering an easily digestible and comprehensive resource for navigating these complex changes.

Key Takeaways

  • Gain a solid understanding of right-of-use assets and lease liabilities
  • Compare lease accounting standards, such as ASC 842, IFRS 16, and GASB 87
  • Discover how these changes impact financial statements and reporting.

Understanding Right-of-Use Assets

A right-of-use (ROU) asset allows you to utilize a leased item for the length of a contracted lease term. This allows you to reap the economic advantages of employing an asset owned by another party. Covering assets in finance and operating leases, ROU assets form a crucial aspect of lease accounting and classification, including capital leases with an option to purchase. Remember that this term is synonymous with “lease asset” under GASB 87.

What is a Lease Liability?

A lease liability is your financial responsibility to pay for a leased asset evaluated on a discounted basis. This concept is recognized under ASC 842, IFRS 16, and GASB 87 standards.

Right-of-Use Asset in accordance with ASC 842

Estimating the Right-of-Use Asset as per ASC 842

Under the ASC 842 standard, the Right-of-Use (ROU) Asset represents the lessee’s right to use an underlying asset for the lease term. After calculating the initial lease liability, you can proceed to estimate the ROU asset. The ROU asset is generally calculated using the following formula:

ROU Asset = Initial Lease Liability + Prepaid Lease Payments – Lease Incentives Received + Initial Direct Costs + Restoration Costs – Any Lease Payments Made at or Before the Commencement Date. Here’s a breakdown of each component:

  1. Initial Lease Liability: This is the present value of future lease payments, calculated as described in your previous question.
  2. Prepaid Lease Payments: These are any payments made to the lessor before the commencement of the lease term.
  3. Lease Incentives Received: Any financial incentives received from the lessor to entice the lessee into the lease agreement. This amount is subtracted from the initial lease liability in the calculation of the ROU asset.
  4. Initial Direct Costs: These are incremental costs that are directly attributable to negotiating and arranging a lease, such as legal fees or commissions.
  5. Restoration Costs: These are estimated costs to dismantle, remove or restore the underlying asset, if required by the terms of the lease agreement. Restoration costs are included if there is a likelihood that the lessee will be responsible for such costs.
  6. Any Lease Payments Made at or Before the Commencement Date: These payments should be subtracted if they have already been made.

By summing these components, you obtain the initial value of the ROU asset, which will then be amortized over the lease term for operating leases or depreciated for finance leases.

The ROU asset and the corresponding lease liability should be presented separately on the balance sheet, though both are crucial for providing a more transparent view of a company’s financial obligations under ASC 842.

Note that the methods and assumptions used to estimate the ROU asset should be carefully documented and applied consistently, as they are subject to audit and must comply with the standard’s requirements.

Example of Right-of-Use Asset Accounting in ASC 842

To provide a more precise understanding, we present a practical example of how our software computes the ROU asset for an operating lease under ASC 842:

Lease Details:

  • Entity Type: Corporate Firm
  • Start Date: October 1, 2023
  • Borrowing Rate: 6%
  • Lease Term: 6 years (October 1, 2023, to September 30, 2029)
  • Lease Payments: $3,000 monthly, commencing October 1, 2023
  • Rent Escalation: 4% annual increment, starting October 1, 2024
  • Initial Direct Cost: $12,000 (capitalized at the beginning of the lease)
  • Incentive: $15,000 (received in cash at lease onset)

Step 1: Lease Liability Computation First, calculate the lease liability using the contractual payments from October 1, 2023, to September, 2029, factoring in the 6% borrowing rate. This results in an approximate present value of $209,358.

Step 2: Calculating the ROU Asset Under the former ASC 840, initial direct costs and incentives for operating leases were capitalized and then depreciated straight-line over the lease duration. Prior to transitioning to ASC 842, one would use amortization schedules for each factor:

To determine the initial ROU asset on October 1, 2023:

  • Initial Liability Balance: $209,358
  • Add: Initial Direct Cost $12,000
  • Less: Incentive ($15,000)

Resulting ROU Asset: $206,358

Step 3: Amortization Schedule After determining the following figures:

  • Total cash payments: $251,111
  • Add: Initial direct cost $12,000
  • Less: Incentive ($15,000)

We get net payments of $248,711. Spread this net payment over the lease duration of 72 months (October 1, 2023 – September 30, 2029) to get a monthly lease expense of $3,446. With the initial lease liability, ROU asset values as of October 1, 2023, and the computed lease expense, one can then structure the amortization schedule.

Leverage Black Owl Systems’ Lease Accounting Software to streamline complex calculations and ensure your business complies with ASC 842 standards.

Right-of-use Asset under IFRS 16

Calculating the Right-of-use Asset under IFRS 16

Under IFRS 16, there is no distinction between operating and finance leases. Instead, a single model approach requires all lessee leases to be reported as finance leases. These leases are capitalized and presented on the balance sheet as assets and liabilities unless they meet any of the exemptions specified by the standard. The lease asset is referred to as a Right-of-use (ROU) asset.

To determine the ROU asset value, follow these steps:

  1. Start with the initial amount of the lease liability.
  2. Add any payments made at or before the lease commencement.
  3. Subtract any lease incentives.
  4. Include initial direct costs.
  5. Add estimated restoration or removal/disposal costs as per IAS 37 Provisions, Contingent Liabilities, and Contingent Assets.

The ROU asset value is calculated using the above components, ensuring an accurate representation of your lease obligations on the balance sheet.

Lease Asset under GASB 87

Calculating the Lease Asset under GASB 87

Under GASB 87, which applies a single-model approach, all leases are classified as finance leases. When recognizing a lease asset, lessees must comply with specific requirements to ensure they have the right to control and derive economic benefits from the asset’s present service capacity. Not all leases must recognize a right-to-use asset or a lease liability under GASB 87. Some examples of exempt leases include:

  • Leases that don’t fit the exchange-like transaction definition
  • Leases with a title transfer provision
  • Leases with a lease term of 12 months or less, including renewal option periods

A conversion entry is needed to transition from a modified accrual accounting basis to the full accrual basis necessary for government-wide financials at year-end.

To determine the initial value of a leased asset, follow this calculation:

  1. Start with the initial lease liability
  2. Add any outstanding prepaid rent amounts
  3. Subtract any cumulative remaining deferred rent
  4. Subtract unamortized incentive balances received at or before the lease commencement
  5. Add initial direct costs incurred to place the asset into service

Right-of-Use Asset Amortization

When dealing with right-of-use (ROU) assets, it’s essential to understand that their amortization depends on the type of lease: operating leases versus finance leases. For operating leases, you should amortize the ROU asset by subtracting the lease liability expense from the total lease expense methodically and logically. On the other hand, finance lease assets are to be amortized using a straight-line basis.

The amortization period for operating lease ROU assets begins from the lease commencement date (when you gain possession of the underlying asset) and extends until the end of the lease term or in some cases, the end of the asset’s useful life. This rule is consistent across finance leases under ASC 842, IFRS 16, and GASB 87. Creating an amortization schedule to track your amortization expenses accurately and ensure compliance over time is essential.

Lease Liability Calculation under ASC 842, IFRS 16, & GASB 87

A lease liability represents the financial responsibility for the required lease payments, discounted to their present value. The calculation of the finance lease liability under ASC 842, IFRS 16, and GASB 87 considers the present value of the remaining lease payments over the lease term. The discount rate implicit in the lease is preferred under all three lease standards. However, when the implicit interest rate cannot be ascertained, each standard allows for utilizing an incremental borrowing rate defined by the respective standard.

Under IFRS 16, lessees must remeasure lease liabilities when future payments change, which may affect balances when lease payments are linked to an index. However, this is not the case under GASB 87 and ASC 842.

Both the initial operating lease liabilities and finance lease liabilities under ASC 842 are calculated in the same manner.

Practical Expedient for Private Companies under ASC 842

ASC 842 provides an additional interest rate option to private companies and nonprofits. Non-public entities can choose a risk-free rate as the discount rate for lease liability calculations. As a result of the FASB’s post-implementation review process, private entities can apply the risk-free rate to a specific class of underlying assets rather than using it for the entire lease portfolio.

Right-of-use Assets and Lease Liabilities: Their Influence and Position on the Balance Sheet

In the past, operating leases allowed lessees to use assets without the benefits of ownership, and the lease payments associated with them were not reflected on the balance sheet. With the introduction of ASC 842, IFRS 16, and GASB 87, a significant shift occurred in lease accounting, resulting in most leases needing to be capitalized.

Now, except for a few exemptions and policy elections, such as leases with terms shorter than 12 months, lessees must recognize all leases with a lease liability and a right-of-use (ROU) asset on the balance sheet. This change affects the balance sheet’s structure and the subsequent measurement and presentation of profits or losses.

The classification of operating leases has also evolved under these new accounting standards, albeit differently. According to IFRS 16 and GASB 87, all leases are considered finance leases, eliminating the “operating lease” classification. However, ASC 842 maintains a distinct classification system with the following updates:

  • The bargain purchase option criteria have been removed. If a lease contains a purchase option, and the lessee is reasonably sure to exercise it, it is classified as a finance lease.
  • The “75% of lease term” and “90% of FMV” rules are no longer definitive. Still, the FASB suggests companies continue using these thresholds unless a better option exists based on their specific circumstances. Entities should develop a consistent policy regarding these thresholds.
  • A new fifth test has been added, requiring entities to evaluate whether the asset is specialized and holds any future value to the lessor.

These adjustments stem from the FASB’s shift towards principle-based rather than rule-based accounting.

In summary, aligning your lease accounting practices with the latest standards will lead to a more accurate representation of your company’s liabilities and assets, particularly about the placement and impact of right-of-use assets and lease liabilities on your balance sheet.


Under various lease accounting standards, a right-of-use (ROU) asset and lease liability are recognized on the balance sheet. You must understand the financial statement presentation and methods to calculate these ROU assets and liabilities. Each standard may contain unique definitions and factors that affect your calculations.

This section helps you understand ROU assets comprehensively concerning financing and operating leases, assisting you in future calculations. If you’re unsure about the type of lease your organization holds, free lease accounting tools are available to provide support. Maintain a confident, knowledgeable, and neutral approach to this topic, and you’ll be well-equipped to handle lease accounting tasks efficiently and accurately.

Frequently Asked Questions

Calculating Depreciation for Right-of-Use Assets

To calculate depreciation for right-of-use assets, divide the initial value of the asset minus its residual value, if any, by the length of the lease term. Depreciation is then expensed periodically over the lease term.

Journal Entries for Right-of-Use Assets and Liabilities

When recording right-of-use assets and corresponding lease liabilities, you should create the following journal entries:

  1. At the commencement of the lease, debit the Right-of-Use Asset account and credit the Lease Liability account for the initial measurement of the right-of-use asset.
  2. As lease payments are made, debit the Lease Liability account and credit the Cash account for the payment amount.
  3. Periodically, debit the Depreciation Expense account and credit the Accumulated Depreciation account for the calculated depreciation amount.

Right-of-Use Assets on the Balance Sheet

A right-of-use asset appears on the balance sheet as a separate line item or as part of the fixed assets, depending on the company’s accounting policies and presentation choices.

Classification of Right-of-Use Assets

Yes, right-of-use assets are considered a type of fixed asset since they represent a company’s right to use a leased asset over a specified period.

IFRS 16 and the Treatment of Right-of-Use Assets

Under IFRS 16, lessees are required to recognize right-of-use assets and lease liabilities on their balance sheets for almost all lease contracts, thereby eliminating the previous operating and finance lease distinctions. This brings greater transparency and comparability to financial statements.

Tax Treatment of Right-of-Use Assets

The tax treatment of right-of-use assets varies depending on the jurisdiction and specific tax laws. Generally, depreciation expenses on right-of-use assets and the corresponding lease payments can be deductible for tax purposes. It’s essential to consult with a tax expert or refer to the relevant tax authorities for specific guidance in your jurisdiction.

Greg Kautz
Greg Kautz

Greg Kautz, CPA, CMA

Latest Blog Posts

News & Press Releases