What is a right-of-use asset? A plain-English IFRS 16 guide

A right-of-use (ROU) asset is the amount a lessee recognises on its balance sheet representing the right to use a leased asset for the term of the lease. Under IFRS 16 and its Australian equivalent AASB 16, the ROU asset is initially measured at the present value of future lease payments, plus initial direct costs, prepaid amounts, and estimated make-good costs, less any lease incentives received.

If your organisation leases office space, equipment, or vehicles, those leases now appear on your balance sheet as both an ROU asset and a corresponding lease liability. This guide explains what the ROU asset is, how it's calculated, and where finance teams commonly go wrong.

Updated April 2026.

Why IFRS 16 introduced the right-of-use asset

Before IFRS 16 took effect (for most organisations, financial years beginning on or after 1 January 2019), operating leases were largely invisible on the balance sheet. Companies disclosed future commitments in the notes to their financial statements, but nothing appeared as an asset or liability. That approach made it genuinely difficult to compare the financial position of organisations that owned their assets with those that leased them.

The International Accounting Standards Board designed IFRS 16 to fix this. The core principle is straightforward: if you control the right to use an asset for a period of time, that right has economic value and should appear on your balance sheet. The ROU asset represents that value. Its paired entry, the lease liability, reflects your obligation to make future payments.

For Australian reporters, AASB 16 is the local equivalent and is substantively identical to IFRS 16 for lessees. The ROU asset recognition and measurement requirements are the same under both standards.

What gets included in the initial ROU asset value

The initial measurement of the ROU asset starts with the lease liability and then adds several adjustments. Specifically, the initial ROU asset equals:

• The initial measurement of the lease liability: the present value of future lease payments, discounted at the rate implicit in the lease or, if that rate cannot be readily determined, your incremental borrowing rate (IBR).
• Plus: initial direct costs. Incremental costs of obtaining the lease that would not have been incurred but for the lease, such as legal fees for negotiating lease terms or broker commissions.
• Plus: prepaid lease payments. Any payments made at or before the lease commencement date (net of incentives already received).
• Plus: estimated make-good or restoration costs. Where the lease contains a clause requiring the lessee to restore the asset to its original condition at the end of the term, the provision recognised under IAS 37 (or AASB 137 in Australia) is added to the ROU asset at commencement.
• Less: lease incentives received. Any cash incentives or rent-free periods provided by the lessor reduce the initial ROU asset value.

Getting each of these inputs right at the commencement date matters because every subsequent calculation (depreciation, impairment, modification adjustments) flows from this opening figure. Errors here compound over the life of the lease. For a deeper look at the calculation mechanics, the IFRS 16 calculations guide walks through the Excel setup in detail.

How the ROU asset is measured after initial recognition

Once recognised, the ROU asset is typically carried at cost less accumulated depreciation and any accumulated impairment losses. The depreciation model is straightforward.

The ROU asset is depreciated on a straight-line basis over the shorter of the asset's useful life or the lease term. If you have a reasonable certainty of exercising a purchase option at the end of the lease, then you depreciate over the useful life of the underlying asset instead.

Determining the correct depreciation period requires judgement. The lease term under IFRS 16 is not just the non-cancellable period. It includes any extension options the lessee is reasonably certain to exercise and excludes any termination options the lessee is reasonably certain to exercise. This assessment must be made at commencement and reassessed when a significant event or change in circumstances occurs.

Impairment testing also applies. ROU assets are subject to IAS 36 (AASB 136 in Australia), which means that if indicators of impairment exist, you need to assess whether the carrying amount exceeds the recoverable amount and write down accordingly.

Note that IFRS 16 also permits a revaluation model for ROU assets in the same class as property, plant, and equipment where the lessee applies the revaluation model to owned assets. This is less common in practice but is available where relevant.

How lease modifications affect your ROU asset

A lease modification is any change to the scope or consideration of a lease that was not part of the original terms. Common examples include extending the lease term, adding or removing leased space, or renegotiating the rental amount. When a modification occurs, it triggers a remeasurement of the lease liability first, with the corresponding adjustment flowing through to the ROU asset.

When you remeasure the lease liability upward (for example, when extending a lease), the ROU asset increases by the same amount. When the liability decreases (for example, after a partial termination reducing leased space), the ROU asset decreases. If the carrying amount of the ROU asset is reduced to zero but a further reduction is required, the excess is recognised in profit or loss.

Some modifications are treated as a separate new lease entirely, such as when the modification grants an additional right-of-use asset not included in the original lease and the lease payments increase commensurately. In those cases, a new ROU asset is recognised for the added component at commencement of the modified lease.

Lease modifications are one of the most error-prone areas in practice. Organisations with large portfolios often face dozens of modifications each month, making manual tracking unreliable. The IFRS 16 audit preparation checklist covers what auditors specifically look for in modification accounting.

ROU asset vs lease liability: how they relate

The ROU asset and the lease liability always exist together; one cannot be recognised without the other. But they behave differently over time, and this is something finance teams frequently find counterintuitive.

The lease liability unwinds at the interest rate used to discount the lease payments. Early in the lease, a larger proportion of each payment reduces interest rather than principal, similar to a mortgage. The liability declines more slowly at first and accelerates toward the end of the lease term.

The ROU asset depreciates on a straight-line basis. It reduces by the same amount each period regardless of the payment pattern. Because the two balances move at different rates, the carrying value of the ROU asset and the outstanding lease liability will almost never match after commencement (unless the discount rate happens to produce level amortisation). This is expected and correct, not an error.

The income statement also reflects this split. Depreciation on the ROU asset runs through operating expenses. Interest on the lease liability runs through finance costs. This changes key financial ratios compared to the old operating lease treatment, including EBITDA, which increases because lease costs are now below the EBITDA line. For a detailed view of these financial statement effects, see the post on how IFRS 16 affects financial statements.

A practical example: recognising an office lease

Here is a simplified example to ground the concepts above.

Scenario: An Australian company enters a 5-year office lease with monthly payments of AUD 10,000. The incremental borrowing rate is 5% per annum. The company incurs AUD 5,000 in initial direct costs (legal fees). There are no lease incentives and no make-good obligation.

Step 1: Calculate the present value of lease payments. Using a monthly discount rate derived from the 5% IBR*, the present value of 60 monthly payments of AUD 10,000 is AUD 533,503.

Step 2: Calculate the initial ROU asset.

• Present value of lease payments: AUD 533,503
• Initial direct costs: AUD 5,000
• Initial ROU asset: AUD 538,503

The initial lease liability is AUD 533,503 (the present value of payments only, before adding direct costs).

Step 3: Calculate Year 1 depreciation. The ROU asset is depreciated on a straight-line basis over 5 years (60 months). Annual depreciation = AUD 538,503 / 5 = AUD 107,701 per year (approximately AUD 8,975 per month).

At the end of Year 1, the ROU asset carrying value is approximately AUD 538,503 minus AUD 107,701 = AUD 430,802. Meanwhile, the lease liability has reduced by actual payments made less interest accrued, arriving at a different balance of AUD 436,953. Both are correct but carry a different profile due to the interest cost.

*Note that the interest rate can be calculated as nominal or effective interest, which will produce slightly different present values. The figures above use an effective interest rate approach.

Common mistakes in ROU asset accounting

These five errors appear repeatedly in practice, including in auditor findings:

• Using the non-cancellable period only as the lease term. IFRS 16 requires you to include extension options that are reasonably certain to be exercised. An organisation with a 3-year lease and a 3-year extension it intends to take has a 6-year lease term for accounting purposes. Getting this wrong understates both the ROU asset and the lease liability.
• Depreciating over the wrong period. The ROU asset must be depreciated over the shorter of the lease term or the underlying asset's useful life. Depreciating over the asset's full economic life when the lease term is shorter will overstate the asset on the balance sheet toward the end of the lease.
• Omitting initial direct costs. Legal fees, broker commissions, and other incremental costs of obtaining the lease are part of the ROU asset. Expensing them directly through profit or loss instead understates the asset at commencement.
• Ignoring make-good provisions. Where a lease includes a restoration obligation, the estimated cost must be recognised as a provision and added to the ROU asset at commencement. Omitting this understates both the asset and the corresponding liability.
• Failing to reassess extension options after a significant event. IFRS 16 requires reassessment when circumstances change, such as a significant leasehold improvement or a business decision to relocate. Treating the lease term as fixed from commencement ignores this requirement and can result in a material misstatement.

For a broader view of the compliance pitfalls finance teams encounter, the post on common IFRS 16 mistakes and how a lease accounting system fixes them is worth reading alongside this one.

How LOIS automates ROU asset calculations

LOIS is an expert-led lease accounting and management platform built for organisations managing portfolios of 30 to 10,000+ leases. At commencement, LOIS captures the lease inputs (payments, IBR, initial direct costs, make-good provisions, lease incentives) and calculates the initial ROU asset and lease liability automatically. Every input is recorded with a full audit trail.

When a lease is modified, LOIS triggers the remeasurement workflow, recalculates the revised lease liability, and adjusts the ROU asset accordingly. Depreciation schedules are updated automatically, and the revised journals are prepared and ready for posting. The platform is supported by CA-qualified lease accounting experts who review inputs and calculations as part of the managed service offering.

For more on the platform's compliance capabilities, see the LOIS lease accounting software page. For a complete walkthrough of IFRS 16 for organisations new to the standard, the post on IFRS 16 exemptions covers the low-value and short-term asset exclusions that may reduce the number of ROU assets your organisation needs to recognise.

Frequently asked questions

Is a right-of-use asset a fixed asset?
An ROU asset is presented on the balance sheet similarly to a fixed asset, but it is a separate class of asset under IFRS 16. It represents the right to use a leased item, not ownership of it. Some entities present ROU assets within property, plant, and equipment on the face of the balance sheet; others show them separately. Either presentation is permitted as long as it is disclosed.

What is the difference between the ROU asset and the lease liability?
The ROU asset is the lessee's right to use the underlying asset and is measured at cost less depreciation. The lease liability is the obligation to make future lease payments, measured at the present value of those payments. They are recognised together at commencement but move at different rates: the ROU asset depreciates on a straight-line basis, while the lease liability unwinds at the effective interest rate.

Do short-term leases and low-value asset leases require an ROU asset?
No. IFRS 16 provides two practical expedients: lessees may elect not to apply the standard to leases with a term of 12 months or less (short-term leases) and to leases of low-value assets (such as laptops or small office equipment, typically below USD 5,000 in value when new). If either exemption applies, lease payments are recognised as an expense on a straight-line basis and no ROU asset or lease liability is recognised. For full detail on these exemptions, see the post on IFRS 16 exemptions.

Can the ROU asset be impaired?
Yes. ROU assets are subject to the impairment requirements of IAS 36 (AASB 136 in Australia). If there are indicators that the carrying amount of the ROU asset exceeds its recoverable amount (the higher of fair value less costs of disposal and value in use), an impairment loss must be recognised. Common indicators include a decision to vacate leased premises or a significant decline in the profitability of the cash-generating unit that uses the leased asset.

How does AASB 16 differ from IFRS 16 for ROU assets?
For lessees, AASB 16 is substantively identical to IFRS 16. The recognition, initial measurement, and subsequent measurement requirements for ROU assets are the same under both standards. The primary differences relate to the not-for-profit sector modifications included in AASB 16, which do not affect the ROU asset calculations for for-profit entities.