Right-of-use assets (ROU) represent a lessee’s right to use an asset over the course of a lease.
More formally, an ROU asset is an identified property, plant, or equipment—in other words, an identified asset—that is leased by an entity. The use of this asset by the lessee must be pursuant to the definition of the right of use in the new lease accounting standards: ASC 842 for US GAAP, GASB 87 for US governmental entities, and IFRS 16 for international accounting.
Most lease assets are now recorded on the Balance Sheet in the form of an ROU Asset and Lease Liability. Right-of-use assets are intangible assets.
Under ASC 842, the amortization period is the length of the lease term, except when ownership is transferred to the lessee at the end of a finance lease. In this case, the lease is amortized over the useful life of the asset.
ROU stands for “right of use.” The concept of right-of-use is now a crucial aspect of lease accounting within the parameters of the new lease accounting standards. These accounting standards characterize how a lessee should record the value of the ROU Asset and Lease Liability over the period of a contract.
The ROU Asset is calculated as:
The initial amount of the lease liability
+
Lease payments made to the lessor before the lease commencement date
+
Initial direct costs incurred
-
Lease incentives received
=
ROU asset
Each component of this equation proves important in understanding the value of the ROU asset. The ROU Asset calculation begins with the lease liability because it is the present value of future lease payments.
Initial direct costs are also important for the calculation of the ROU asset because they are connected directly to the asset in the lease that the lessee has the right to use over the course of the lease.
Most considerations for ROU asset calculation are the same for both finance and operating leases. For both types of leases, an ROU Asset has to:
Finance Lease ROU Assets:
Operating Lease ROU Assets:
An example of the calculation of the right-of-use asset is as follows:
An asset has a five-year rental period without a renewal option, a $10,000 lease payment at the beginning of each month, and an incremental borrowing rate of 6% with initial direct costs of $2,000.
First, calculate the lease liability, which is the present value of the 60 monthly payments discounted at 6%, for a total of $509,842. When a payment is made at the beginning of the lease term, it is not included in the Lease Liability.
The ROU asset is the lease liability ($509,842) + initial direct costs ($2,000) + prepayments ($10,000) - lease incentives ($0) = $521,842.
The objective of the disclosure requirements is to provide transparent, useful information about a company’s leasing activities. Lessees shall include a general description of leases, details on how variable expenses are determined, and a narrative regarding the options to extend or terminate that are recognized or not recognized as part of the ROU Asset and Lease Liability. Residual value guarantees are expected to be paid by the lessee to the lessor.
Lessees should also include finance lease cost, separating both the amortization of the right-of-use assets and interest on lease liabilities; operating lease cost; variable lease cost; sublease income; net gain or loss recognized from sale and leaseback transactions; and cash paid for amounts included in the measurement of lease liabilities.
Furthermore, lessees should include the weighted average remaining lease term and weighted average discount rate separately for both finance and operating leases, as well as a maturity analysis showing undiscounted cash flows.
When a lease change requires a remeasurement of the Lease Liability and ROU Asset, lessees should re-evaluate the lease payments, allocating consideration to the lease and non-lease components. The lessee should also update the discount rate and reassess the classification of the lease. When the Lease Liability is remeasured, the ROU Asset will also change. If the ROU Asset is reduced to zero, any remaining balance is recorded as a Gain or Loss.
Under ASC 842, ROU Assets do not impact how leases are treated for federal income tax purposes.
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A right-of-use asset represents a lessee’s right to use an asset over the course of a lease. Typically, it’s an identified property, plant, or equipment that is leased by an entity.
Right-of-use assets are calculated by finding the sum of the initial amount of the lease liability, the lease payments made to the lessor at or before the lease commencement date, and the initial direct costs incurred. Once you find that sum, subtract the lease incentives received. Then you will be able to calculate your ROU asset.
Right-of-use assets are generally classified as non-current assets on a balance sheet.
Right of use refers to the lessee’s right to use an asset over the duration of a lease.
Right-of-use assets can be either an operating lease or a finance lease.
ROU Assets are recorded on the balance sheet as noncurrent assets.
An ROU Asset is measured by taking the initial amount of the lease liability plus any lease payments made to the lessor at or before the lease commencement date, plus initial direct costs incurred, minus lease incentives received from the lessor at or before commencement.
ROU Assets are amortized on a straight-line basis for the life of the lease.
A higher discount rate causes the ROU Asset to be lower, and a lower discount rate causes the ROU Asset value to be higher.
When a lease modification does not meet the requirements necessary to be reported as a separate new lease, the existing lease is modified. The type of modification to the lease will dictate how the ROU Asset is affected.
ROU Assets are long-lived nonfinancial assets and fall within the scope of Topic 360: Property, Plant and Equipment. An impairment is usually not within the control of a lessee. When an ROU Asset is impaired, the ROU Asset value is reduced; however, the Lease Liability is not.
The calculations for determining the ROU Asset are the same regardless of lease classification. Once the lease classification is determined, the subsequent measurement of the ROU Asset is based on that classification. For Finance Leases, the amortization of the ROU Asset occurs on a straight-line basis and is recorded separately from Interest Expense. For Operating Leases, straight-line expense is recorded as total payments divided by the lease term.
