Key Takeaways
- The right-of-use (ROU) asset represents the lessee's right to use an underlying asset over the lease term
- Initial measurement starts with the lease liability, plus initial direct costs, prepayments, and restoration costs
- Depreciation is typically straight-line: over the useful life if ownership transfers or a purchase option is expected to be exercised, otherwise over the shorter of the lease term and useful life
- Three measurement models are available: cost model (most common), revaluation model, and fair value model
- ROU assets must be tested for impairment under IAS 36 when indicators exist
What is a Right-of-Use Asset?
The right-of-use (ROU) asset represents a lessee's right to use an underlying asset for the lease term. It's recognised on the balance sheet at the lease commencement date alongside the corresponding lease liability.
Under IFRS 16, the ROU asset is essentially a capitalised lease - it reflects the economic benefit of having access to and control over an asset, even though legal ownership remains with the lessor.
IFRS 16 Definition
"At the commencement date, a lessee shall measure the right-of-use asset at cost."
- IFRS 16.23 (cost components defined in IFRS 16.24)
Initial Measurement
The cost of the ROU asset at commencement comprises several components:
Components of Initial Cost
| Component | Description | Example |
|---|---|---|
| Lease liability | Present value of future lease payments at commencement | See lease liability calculation |
| Initial direct costs | Incremental costs of obtaining a lease that would not have been incurred if the lease had not been obtained | Legal fees, broker commissions |
| Prepayments | Lease payments made before or at commencement | First month's rent paid on signing, advance rent payments |
| Less: Lease incentives | Incentives received from the lessor to enter the lease | Cash contributions, fit-out allowances |
| Restoration costs | Initial estimate of dismantling, removing, or restoring obligations incurred by the lessee (recognised as a provision under IAS 37) | Obligation to remove partitions, make good on a property lease |
Initial Direct Costs
Initial direct costs are only those that would not have been incurred if the lease had not been obtained. General overheads, costs of negotiating leases that don't proceed, and internal allocation of costs typically don't qualify.
Worked Example: Initial Recognition
Scenario
A company enters into a 5-year office lease with the following terms:
- Lease liability at commencement: £550,000
- Legal and broker fees: £15,000
- Three months' rent paid in advance: £30,000
- Fit-out contribution received from landlord at commencement: £25,000
- Estimated restoration costs (present value): £20,000
Calculation
| Component | Amount |
|---|---|
| Lease liability | £550,000 |
| Initial direct costs | £15,000 |
| Prepayments | £30,000 |
| Less: Lease incentives | (£25,000) |
| Restoration provision | £20,000 |
| Right-of-Use Asset | £590,000 |
Journal Entry at Commencement
The £30,000 advance rent was paid before commencement and sits in prepayments. At commencement it is reclassified into the ROU asset. Legal fees are assumed paid and the fit-out contribution received at commencement, giving a net cash inflow of £10,000 on day one.
Subsequent Measurement
After initial recognition, the ROU asset must be depreciated and tested for impairment. The measurement model depends on the nature of the underlying asset and the entity's existing accounting policies.
Available Measurement Models
Cost Model
The most common approach. The ROU asset is measured at cost less accumulated depreciation and impairment losses, adjusted for remeasurements of the lease liability.
Applies to most leases (vehicles, equipment, most property)
Revaluation Model
Can be used if the lessee applies IAS 16 revaluation model to owned assets of the same class. ROU assets are revalued to fair value periodically.
Requires all assets in class to be revalued
Fair Value Model
Must be used when the ROU asset meets the definition of investment property and the lessee uses the fair value model for its investment properties under IAS 40.
Applies to subleased property or property held to earn rentals
Consistency Requirement
The measurement model must be applied consistently to all ROU assets within the same class of underlying assets. For example, if you use the cost model for one vehicle lease, you must use it for all vehicle leases.
Depreciation
Under the cost model, ROU assets are depreciated in accordance with IAS 16. Straight-line depreciation is most commonly used.
Depreciation Period
The depreciation period depends on whether ownership transfers at the end of the lease:
| Scenario | Depreciation Period |
|---|---|
| Ownership transfers to lessee at end of lease | Useful life of the underlying asset |
| Lessee reasonably certain to exercise purchase option | Useful life of the underlying asset |
| All other leases | Shorter of lease term and useful life |
Annual Depreciation Calculation
The ROU asset often has no residual value to the lessee at the end of the lease term, because the asset returns to the lessor.
Depreciation Example
Using our example with a £590,000 ROU asset and 5-year lease term (no ownership transfer):
| Year | Opening Balance | Depreciation | Closing Balance |
|---|---|---|---|
| 1 | 590,000 | (118,000) | 472,000 |
| 2 | 472,000 | (118,000) | 354,000 |
| 3 | 354,000 | (118,000) | 236,000 |
| 4 | 236,000 | (118,000) | 118,000 |
| 5 | 118,000 | (118,000) | 0 |
| Total | (590,000) |
Depreciation Journal Entry
Lease Termination
For leases where the asset returns to the lessor (no ownership transfer or purchase option), the ROU asset should be fully depreciated by the end of the lease term. A final journal entry removes both the gross asset and accumulated depreciation from the balance sheet.
This is a ledger clearing entry with no impact on net assets or profit/loss. It removes the gross asset and accumulated depreciation from the balance sheet once the asset is fully depreciated and the lease has ended.
Impairment
ROU assets measured under the cost model are subject to impairment testing under IAS 36. An impairment review should be performed when there are indicators that the ROU asset may be impaired.
Common Impairment Indicators
- The leased premises are no longer being used
- Significant decline in the market value of similar assets
- Plans to terminate the lease early
- Subleasing at rates below the head lease cost
- Changes in the economic environment affecting the asset's utility
If impaired, the ROU asset is written down to its recoverable amount, and an impairment loss is recognised in profit or loss.
For detailed guidance, see our Impairment guide.
Adjustments for Remeasurements
When the lease liability is remeasured, the ROU asset is typically adjusted by the same amount. Common remeasurement triggers include:
- Changes in the lease term assessment
- Changes in the assessment of purchase option exercise
- Changes in amounts expected under residual value guarantees
- Changes in future lease payments from index/rate changes
ROU Asset Cannot Go Negative
If a remeasurement would reduce the ROU asset below zero (for example, from a significant reduction in lease term), the excess reduction is recognised in profit or loss rather than as a negative asset balance.
For detailed guidance on when remeasurements occur, see our Remeasurement guide.
Presentation and Disclosure
Balance Sheet
ROU assets can be presented in one of two ways:
- Separately - as a distinct line item
- Within the same category - as if the underlying assets were owned (e.g., within Property, Plant and Equipment), with disclosure of which line items include ROU assets
ROU assets meeting the definition of investment property must be presented within investment property.
Key ROU Asset Disclosures
- Depreciation charge for ROU assets by class of underlying asset
- Additions to ROU assets during the period
- Carrying amount of ROU assets at period end by class
- Details of any impairment losses recognised
This is a subset of the full lessee disclosure requirements under IFRS 16.53-59. For the complete list, see our Disclosure Requirements guide.
This article is provided for general informational purposes only and does not constitute accounting, legal or professional advice.