Right of Use (ROU) Asset

An ROU asset represents a company's right to use a leased asset for a specified period as outlined in a lease agreement. This type of asset reflects the potential economic benefits the company expects to derive throughout the lease term. According to the international accounting standard IFRS 16, a lease term encompasses the non-cancellable period during which a lessee has a right to use an asset, including any extensions if the lessee is reasonably certain to exercise that option.

IFRS 16 mandates the method by which companies should recognize, measure, present, and disclose information regarding leases. The standard requires lessees to recognize assets and liabilities for most leases. Exceptions are made when the lease term is 12 months or less or when the underlying asset has a low value.

The accurate determination of an ROU asset's cost is pivotal. It involves computing the present value of lease payments over the term of the lease, discounted at the lessee's incremental borrowing rate. We provide a Microsoft Excel template to facilitate this calculation, which can be found in our knowledge database. This template assists in computing the precise cost of the ROU asset, the initial measurement of lease liability, and the accrued interest.

For example, accounting for an ROU asset and incorporating it into the balance sheet would involve the following journal entries. It should be noted that at the conclusion of the lease term, typically five years, both the Leased Liability and ROU Asset accounts will have been fully amortized to zero.

Year 1

• Debit: ROU Asset $39,970.63

• Credit: Lease Liability $39,770.63

• Credit: Cash $200.00

The above entries reflect the initial capitalization of the ROU asset and recognition of the lease liability. Subsequent entries record the payment of the first year's lease liability installment, including interest, and the annual amortization of the ROU asset.

Year 2

• Debit: Lease Liability $10,000

• Credit: Cash $10,000

• Debit: Interest on Lease Liability $3,374.77

• Credit: Lease Liability $3,374.77

These entries would be repeated for years 3 and 4, adjusting the interest amount as necessary.

Year 5

• Debit: Lease Liability $13,000

• Credit: Cash $13,000

• Debit: Interest on Lease Liability $1,181.82

• Credit: Lease Liability $1,181.82

The final installment payment of the lease liability is recorded in year 5.