Right-of-Use Asset: Definition, Calculation, and IFRS 16 Accounting Treatment

The right-of-use asset is one of the two balance sheet items that IFRS 16 requires lessees to recognise — the other being the lease liability. Together, they represent what was previously invisible: the economic reality that a business using a leased property or piece of equipment has obtained something of value, and incurred an obligation in exchange.

Understanding exactly what the right-of-use asset is, how it is measured, and how it moves through the financial statements is essential for any finance team managing a lease portfolio under IFRS 16 or its Indian equivalent, Ind AS 116.

What Is a Right-of-Use Asset?

A right-of-use (ROU) asset represents a lessee's right to use an underlying asset for the lease term. It is an intangible right — not ownership of the asset, but the contractual entitlement to use it.

Under IFRS 16, this right has economic value. A 5-year lease on a retail store location in a high-traffic area represents a significant economic benefit: the ability to trade from that location for five years. The standard requires that economic benefit to appear on the balance sheet, alongside the corresponding obligation to pay for it (the lease liability).

The concept is straightforward. The accounting complexity arises from how the asset is measured at commencement and how it is subsequently carried — and from the modifications, impairments, and remeasurements that arise over the life of a lease portfolio.

Which Leases Require a Right-of-Use Asset?

IFRS 16 requires a lessee to recognise a right-of-use asset for virtually all leases, with two practical expedients:

Short-term leases: A lessee may elect not to recognise a right-of-use asset and lease liability for leases with a term of 12 months or less. Lease payments are recognised on a straight-line basis as an expense.

Low-value asset leases: A lessee may elect not to recognise a right-of-use asset for leases of underlying assets of low value (typically assets costing approximately USD 5,000 or less when new — office printers, laptops, small pieces of equipment). This election is made on a lease-by-lease basis.

All other leases — office premises, retail stores, warehouses, data centre space, vehicles, heavy equipment, manufacturing machinery — require right-of-use asset recognition.

For an enterprise with 100 retail locations, 20 warehouses, and a fleet of vehicles, virtually the entire lease portfolio generates right-of-use assets on the balance sheet.

Initial Measurement: How to Calculate the ROU Asset

At commencement of the lease, the right-of-use asset is measured at cost. That cost comprises:

Component 1: Initial Measurement of the Lease Liability

The largest component of the ROU asset's initial cost is the present value of the future lease payments — which is also the initial measurement of the lease liability.

The lease liability is the present value of:

• Fixed lease payments (less any lease incentives receivable)
• Variable payments depending on an index or rate (measured using the current index/rate)
• The exercise price of a purchase option, if reasonably certain to exercise
• Payments in optional extension periods, if reasonably certain to extend
• Penalties for termination, if the lease term reflects early exercise of a termination option

This present value is calculated using the interest rate implicit in the lease. Where that rate is not readily determinable (common with property leases), the lessee uses its incremental borrowing rate (IBR) — the rate it would pay to borrow, over a similar term and with similar security, the funds necessary to obtain an asset of similar value.

Component 2: Lease Payments Made At or Before Commencement

Any cash payments made to the lessor at or before the lease commencement date (net of any lease incentives received from the lessor) are added to the ROU asset cost.

A common example: a prepaid rent payment or an upfront deposit reclassified as rent. If ₹5,00,000 was paid before the lease began as an advance rent against the first two months, that amount forms part of the initial ROU asset.

*Note: Refundable security deposits are not included. These remain financial assets under IFRS 9.*

Component 3: Initial Direct Costs

Incremental costs of obtaining the lease — costs that would not have been incurred but for the lease — are added to the ROU asset. This includes legal fees for negotiating the lease, commissions paid to agents, and costs of preparing documentation.

Costs that are not incremental — internal management time, overhead allocations — are excluded.

Component 4: Estimate of Dismantling or Restoration Costs

If the lease agreement requires the lessee to restore the leased asset to its original condition or dismantle leasehold improvements at the end of the lease term, the present value of those estimated costs is included in the initial ROU asset measurement.

For retail leases, this is often material. A fit-out obligation to restore the space to bare shell at lease end may represent a significant liability — and a corresponding addition to the ROU asset at commencement.

Worked Example

Retail store lease parameters:

• Commencement: 1 July 2024
• Non-cancellable term: 5 years
• Monthly fixed rent: ₹4,00,000
• IBR: 9% per annum (0.75% per month)
• Advance payment before commencement: ₹3,00,000 (applied to first month's rent in arrears)
• Initial direct costs (legal fees): ₹75,000
• Estimated restoration costs at end of lease: ₹2,00,000 (present value)

Step 1: Lease liability at commencement

PV of 60 monthly payments of ₹4,00,000 at 0.75% per month:

PV = 4,00,000 × [1 − (1.0075)^−60] / 0.0075 PV = 4,00,000 × [1 − 0.6387] / 0.0075 PV = 4,00,000 × 48.17 Lease liability = ₹1,92,68,000 (approximately)

Step 2: ROU asset at commencement

Subsequent Measurement of the ROU Asset

After commencement, the right-of-use asset is carried at cost less accumulated amortisation and any accumulated impairment losses — and is adjusted for any remeasurement of the lease liability.

Amortisation

The ROU asset is amortised on a straight-line basis over the shorter of:

• The lease term (as determined under IFRS 16)
• The remaining useful life of the asset

In most cases for property leases, the lease term is shorter than the useful life of the building, so amortisation runs over the lease term.

Monthly amortisation = ROU asset cost ÷ lease term (in months)

For the example above: ₹1,98,43,000 ÷ 60 = ₹3,30,717 per month

Adjustments for Lease Liability Remeasurements

When the lease liability is remeasured — because of a change in lease term assessment, a change in index-linked payments, or a lease modification — the right-of-use asset is adjusted by the corresponding amount.

This means the ROU asset is not static between commencement and expiry. It changes whenever the lease terms change. The adjustment goes through the ROU asset, not through profit or loss (except in specific circumstances).

Impairment

ROU assets are subject to IAS 36 impairment testing. If there are indicators that the right-of-use asset may be impaired — for example, a store that is significantly underperforming and is unlikely to recover — the carrying value must be tested against its recoverable amount.

Impairment losses are recognised in profit or loss. A subsequent reversal is permitted if the circumstances change.

Presentation in the Balance Sheet

IFRS 16 gives lessees a choice of presentation:

Option 1: Present right-of-use assets as a separate line item on the face of the balance sheet (or disclose which line items include them).

Option 2: Include right-of-use assets within the same line items as equivalent owned assets (e.g., show ROU assets for property within property, plant and equipment; show ROU assets for equipment within equipment).

Most enterprises opt for a separate ROU asset line in non-current assets, providing clarity to readers of the financial statements on the scale of the lease portfolio and its balance sheet impact.

The Difference Between the ROU Asset and the Lease Liability

A common source of confusion: the ROU asset and the lease liability start at similar (but not identical) values and then diverge over time.

The lease liability decreases as payments are made, but increases with interest accrued. The cash flow pattern determines how quickly it unwinds.

The ROU asset amortises in a straight line, regardless of the payment pattern.

This divergence means the asset and liability are almost never the same after commencement — and in the later years of a lease, the liability will typically be lower than the ROU asset's carrying value (because early payments in the effective interest method carry a higher interest component).

Readers of financial statements should not expect them to match.

Why This Matters Beyond Compliance

For enterprises with large lease portfolios, the ROU asset total is not an accounting artefact. It is a real measure of economic exposure — the value of the right to occupy and operate from every leased location.

Understanding the ROU asset balance by property, by entity, and by lease vintage helps operations and finance teams make better decisions: which leases represent declining-value positions worth early termination, which represent options worth exercising, and where the portfolio is exposed to modifications that will trigger remeasurement and balance sheet movement.

Hubler's Lease Management solution maintains the complete ROU asset schedule for every lease — initial measurement, monthly amortisation, modification adjustments, and impairment testing support — with full audit trail and ERP posting for every journal. For enterprises managing IFRS 16 and Ind AS 116 across multiple entities and currencies, the alternative is a spreadsheet portfolio that breaks under the weight of its own complexity.

Related Reading

• IFRS 16: Complete Guide for Finance and Operations Leaders
• Lease Amortisation Schedule: How to Build One Under IFRS 16

*Managing right-of-use assets across a complex lease portfolio?* Get a Demo →