Right-of-Use Asset and Lease Liability on the Balance Sheet

A right-of-use (ROU) asset is the lessee's right to use a leased asset for the lease term, and it sits on the balance sheet alongside a matching lease liability for the present value of the lease payments still to be made. Under US GAAP (ASC 842) this applies to both operating and finance leases; under IFRS 16 and India's Ind AS 116 there is a single lessee model that treats almost all leases the same way. Leases of 12 months or less can be kept off the balance sheet by election, and IFRS 16 and Ind AS 116 also allow an exemption for leases of low-value assets.

This guide covers how the asset and liability are measured, where they appear on the balance sheet, how the profit and loss and cash flow treatment differ between the frameworks, and a worked five-year property lease.

Why leases are on the balance sheet now

Before ASC 842 and IFRS 16, a business renting premises on an operating lease recorded only the rent expense. Years of committed payments were mentioned in the notes but not shown as a liability. The current standards changed that: if you control the use of an identified asset for a period of time in exchange for payments, you recognise what you control (the ROU asset) and what you owe (the lease liability). The result is a balance sheet that shows the business's real commitments.

Measuring the lease liability

At the commencement date, the lease liability is the present value of the lease payments not yet paid. Payments generally include fixed rent, rent that varies with an index or rate (measured at the rate on the commencement date), amounts expected under residual value guarantees, and the exercise price of a purchase option you are reasonably certain to exercise.

The discount rate is the rate implicit in the lease if it can be readily determined, which is rare for a tenant. Otherwise you use your incremental borrowing rate — what it would cost you to borrow, on a secured basis over a similar term, the funds needed to obtain a similar asset. Under ASC 842, entities that are not public business entities may instead elect a risk-free rate, by class of underlying asset; a lower rate produces a larger liability.

Measuring the right-of-use asset

The ROU asset starts from the lease liability and is adjusted for amounts paid or received around the start of the lease:

• Plus lease payments made at or before commencement (these reduce what is still owed, so they are not in the liability).
• Plus initial direct costs — incremental costs you would not have incurred without the lease, such as a broker's commission.
• Minus lease incentives received, such as a cash contribution from the landlord.
• Under IFRS 16 and Ind AS 116, plus an estimate of costs to dismantle or restore the site that the lease obliges you to incur. US GAAP handles such obligations through its asset retirement guidance, which also adds the cost to the asset.

Balance sheet presentation

Under ASC 842

• Operating lease ROU assets and finance lease ROU assets must be presented separately from each other and from other assets, either on the face of the balance sheet or by disclosing which line items include them. They may not share a line item.
• The same applies to the two types of lease liability.
• On a classified balance sheet, the ROU asset is non-current, while the lease liability is split into the portion due within 12 months (current) and the rest (non-current).

Under IFRS 16 and Ind AS 116

• ROU assets are presented separately from other assets or disclosed by the line items that contain them, for example within property, plant and equipment.
• Lease liabilities are presented separately from other liabilities or disclosed by line item, with the usual current and non-current split.

Profit and loss and cash flow treatment

This is where the frameworks really diverge.

• ASC 842 operating lease — a single lease cost recognised on a straight-line basis over the term. All cash payments are operating cash flows.
• ASC 842 finance lease — separate amortisation of the ROU asset and interest on the liability, so total expense is higher in early years. Principal repayments are financing cash flows; interest paid is operating.
• IFRS 16 / Ind AS 116 (all recognised leases) — depreciation of the ROU asset plus interest on the liability, front-loaded like a US finance lease. Principal repayments are financing cash flows. Under IAS 7 today, interest paid may be shown in operating or financing by policy; IFRS 18, effective for annual periods beginning on or after 1 January 2027, moves interest paid to financing for most companies. Under India’s Ind AS 7, entities other than financial institutions already classify interest paid as financing.
• Short-term and low-value leases not recognised — expensed, generally straight-line, with payments in operating cash flows.

A practical consequence: the same lease improves EBITDA and operating cash flow under IFRS 16 compared with an ASC 842 operating lease, because the cost is split into depreciation and interest and the principal moves to financing. Bear this in mind when comparing companies across frameworks.

Worked example: a five-year clinic lease

Tidewater Physio signs a five-year lease on clinic premises. Illustrative terms:

• Annual rent — $60,000, paid at the end of each year
• Incremental borrowing rate — 6%
• Broker's commission (initial direct cost) — $4,000
• Cash incentive from the landlord at commencement — $5,000

Initial measurement (same under both frameworks)

• The five-year annuity factor at 6% is about 4.2124, so the lease liability = $60,000 × 4.2124 = $252,742 (rounded).
• ROU asset = $252,742 + $4,000 − $5,000 = $251,742.
• Entry: debit ROU asset $251,742 and cash $5,000 (the incentive received); credit lease liability $252,742 and cash $4,000 (the commission paid).

Year 1 under IFRS 16 or Ind AS 116

• Interest = $252,742 × 6% = $15,165
• Depreciation = $251,742 ÷ 5 = $50,348
• Total expense in year 1 = $65,513
• Liability at year end = $252,742 + $15,165 − $60,000 = $207,907
• ROU asset at year end = $251,742 − $50,348 = $201,394
• Cash flow statement — $44,835 of principal in financing; $15,165 of interest in operating or financing, depending on policy under IAS 7 (financing under Ind AS 7 for a non-financial entity)

Year 1 under ASC 842 as an operating lease

• Straight-line lease cost = (total rent $300,000 − incentive $5,000 + commission $4,000) ÷ 5 = $59,800 a year
• The liability still accretes at 6%, so it ends the year at $207,907, exactly as under IFRS 16.
• The ROU asset is reduced by the difference between the straight-line cost and the interest accretion: $59,800 − $15,165 = $44,635, leaving $207,107.
• Cash flow statement — the full $60,000 is an operating outflow.

Balance sheet at the end of year 1

The year-2 interest will be $207,907 × 6% = $12,474, so $60,000 − $12,474 = $47,526 of principal is due within 12 months. Tidewater shows a current lease liability of $47,526 and a non-current lease liability of $160,381. The ROU asset appears as non-current: $201,394 under IFRS 16 or $207,107 under ASC 842.

Over the full five years, total expense is $299,000 under both frameworks — $251,742 of depreciation plus $47,258 of interest under IFRS 16, or five years of $59,800 under ASC 842. Only the timing differs.

What to watch for

• Lease term judgement. Include extension periods you are reasonably certain to take, and termination options you are reasonably certain not to use. A wrong term changes both the asset and the liability.
• Embedded leases. Service contracts that give you control of a specific asset — a dedicated warehouse area, a specific vehicle — may contain a lease.
• Variable payments. Rent linked to sales or usage is usually expensed as incurred, not included in the liability; rent linked to an index is included at the starting rate.
• Remeasurement. A change in term, an index reset or a lease modification requires the liability to be recalculated, with the ROU asset adjusted to match.
• Debt covenants. Bringing lease liabilities onto the balance sheet can affect gearing ratios. Check how your lender's covenants treat them.

hellobooks< / a > -helps">How HelloBooks helps

HelloBooks does not have a dedicated lease-accounting module, so you calculate the amortisation schedule in a spreadsheet and record the results in your books. HelloBooks then does the rest of the work: you post the initial recognition and each period's interest and lease payment as journal entries, with approval and an audit trail, and the landlord’s rent can be set up as a recurring bill. The ROU asset can be added to the fixed assets register and depreciated straight-line. Separate accounts in the customisable chart of accounts keep the ROU asset and current and non-current lease liabilities on their own lines, so the balance sheet presentation is right, and period-end closing and the cash flow statement pick up the entries automatically. Your accountant should review the lease term, the discount rate and the classification.