IFRS 16 Right-of-Use Asset Guide

What Is a Right-of-Use Asset Under IFRS 16

The right-of-use (ROU) asset is one of the two balance sheet items that every lessee must recognise under IFRS 16. It represents the lessee's right to use an underlying asset — typically office space, retail premises, warehouses, vehicles, or equipment — for the duration of the lease term.

Before IFRS 16 took effect on 1 January 2019, operating leases were off-balance-sheet under IAS 17. The new standard eliminated that distinction. Every qualifying lease now produces two entries: a lease liability (the obligation to make future payments) and a corresponding ROU asset (the right to use the underlying asset). While the lease liability calculation receives most of the attention, the ROU asset has its own complexities — particularly around initial measurement, depreciation, and impairment.

The ROU asset is not the underlying physical asset itself. A lessee holding a 10-year office lease does not own the building. The ROU asset is the economic right to occupy that space for the lease term. This conceptual distinction matters for how the asset is measured, presented, and depreciated.

Recognition Exemptions

IFRS 16 provides two optional exemptions where a lessee need not recognise an ROU asset:

• Short-term leases: Leases with a remaining term of 12 months or less at commencement. Payments are expensed straight-line.
• Low-value assets: Assets with a value of approximately USD 5,000 or less when new (roughly EUR 4,500–5,000). The IASB cited laptops, tablets, and small office furniture as examples.

For all other leases — commercial property, vehicles, heavy equipment, IT infrastructure — the ROU asset must appear on the balance sheet.

Initial Measurement: The Five Components

At the commencement date, the ROU asset is measured at cost. That cost is not simply the lease liability amount — it includes several additional components that can materially affect the carrying value.

Component Breakdown

The formula:

ROU Asset = Lease Liability + Initial Direct Costs + Prepayments + Restoration Costs − Lease Incentives

Worked Example: Office Lease in Munich

Consider a 5-year commercial office lease with these terms:

• Monthly rent: EUR 10,000, payable at end of each month
• Incremental borrowing rate: 4% per annum
• Commencement date: 1 January 2026
• Legal fees for lease negotiation: EUR 3,000
• Broker commission: EUR 2,000
• Estimated end-of-lease restoration (dilapidations): EUR 15,000
• Lessor fit-out contribution received: EUR 8,000
• No prepayments made before commencement

Step 1: Calculate the lease liability

Using the present value annuity formula (60 monthly payments at 0.3333% per month):

Lease Liability = EUR 10,000 × [(1 − (1.003333)^(−60)) / 0.003333]
                = EUR 10,000 × 54.304
                = EUR 543,040

For the detailed calculation methodology, see our lease liability calculation guide or use the IFRS 16 calculator.

Step 2: Calculate the initial ROU asset

The ROU asset (EUR 555,040) is EUR 12,000 higher than the lease liability (EUR 543,040) from day one. This difference is the net of the direct costs, restoration provision, and incentive. Over the lease term, the two amounts will follow different paths — the liability unwinds via the effective interest method, while the ROU asset depreciates on a straight-line basis.

A Note on Restoration Costs

The EUR 15,000 restoration estimate is recognised simultaneously as:

1. An addition to the ROU asset (capitalised cost), and
2. A provision under IAS 37 Provisions, Contingent Liabilities and Contingent Assets.

The provision is not part of the lease liability. It appears separately on the balance sheet and is unwound over the lease term using the pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the obligation.

Subsequent Measurement: The Cost Model

After initial recognition, the ROU asset is measured using the cost model:

Carrying Amount = Initial Cost − Accumulated Depreciation − Accumulated Impairment Losses

This is the same cost model applied to property, plant, and equipment under IAS 16. The vast majority of entities use this model for ROU assets.

Can You Use the Revaluation Model?

Yes, but only if the ROU asset relates to a class of PPE for which the entity already applies the revaluation model under IAS 16. In practice, this is uncommon. If an entity revalues its owned office buildings, it could also revalue ROU assets for leased office buildings — but the additional complexity and valuation cost rarely justify the effort. This guide focuses on the cost model.

Adjustments to the ROU Asset After Initial Recognition

The carrying amount of the ROU asset changes for three reasons:

1. Depreciation — systematic allocation of cost over the lease term (covered in the next section)
2. Impairment — write-down when the recoverable amount falls below carrying amount
3. Remeasurement — adjustments arising from changes to the lease liability (e.g., CPI escalation, option reassessment)

Depreciation of the ROU Asset

Depreciation is the most routine aspect of subsequent measurement. It is also the area where the ROU asset and lease liability begin to diverge.

Depreciation Period

The ROU asset is depreciated over the shorter of:

• The lease term (including any extension periods the lessee is reasonably certain to exercise), or
• The useful life of the underlying asset

Exception: If the lease transfers ownership to the lessee by the end of the lease term, or the cost of the ROU asset reflects that the lessee will exercise a purchase option, the ROU asset is depreciated over the useful life of the underlying asset — which may be considerably longer than the lease term.

For most commercial property leases, the depreciation period equals the lease term. A building's useful life (30–50 years) almost always exceeds the lease term (5–15 years), and ownership rarely transfers.

Depreciation Method

IFRS 16 does not prescribe a specific method. It defers to IAS 16, which requires depreciation to reflect the pattern of consumption of economic benefits. In practice, the straight-line method is used for virtually all ROU assets.

Worked Example

Using our Munich office lease:

• Initial ROU asset: EUR 555,040
• Lease term: 5 years (60 months)
• Useful life of building: 40 years
• Depreciation period: 60 months (shorter of lease term and useful life)
• No ownership transfer or purchase option

Monthly depreciation = EUR 555,040 ÷ 60 = EUR 9,250.67
Annual depreciation  = EUR 9,250.67 × 12 = EUR 111,008.00

After 5 years, the ROU asset is fully depreciated to zero. The depreciation charge appears in the income statement, typically within operating expenses or administrative expenses.

Depreciation Commencement

Depreciation begins at the commencement date — the date the lessor makes the underlying asset available for use. This is not the lease signing date or the date the entity begins fitting out the space. If a lease is signed in November 2025 but the space is made available on 1 January 2026, depreciation begins on 1 January 2026.

Impairment Testing Under IAS 36

ROU assets are subject to impairment testing under IAS 36 Impairment of Assets. This is a critical distinction from FRS 102, which applies Section 27 — the indicators, methodology, and measurement differ.

When to Test for Impairment

IAS 36 does not require annual impairment testing for ROU assets (that requirement applies to goodwill and indefinite-life intangibles). Instead, the entity must assess at each reporting date whether there are indicators of impairment. If indicators exist, a formal impairment test is required.

Common Impairment Indicators for ROU Assets

The Impairment Test

If indicators exist, the entity must estimate the recoverable amount of the ROU asset (or the CGU containing it). The recoverable amount is the higher of:

• Fair value less costs of disposal — what a market participant would pay for the remaining lease rights, less selling costs
• Value in use — the present value of future cash flows expected from continuing to use the asset

If the recoverable amount is less than the carrying amount, the difference is recognised as an impairment loss in profit or loss.

Practical Considerations

For property ROU assets, the impairment test often involves the entire CGU rather than the isolated ROU asset. The leased premises are rarely the only asset in a CGU — they are combined with equipment, inventory, and other assets used in operations. The impairment test compares the CGU's total carrying amount (including the ROU asset) against the CGU's recoverable amount.

Impairment of an isolated ROU asset is more straightforward when the entity can directly compare the lease cost to current market rates. If the entity is paying EUR 10,000/month for space that now commands EUR 6,000/month in the market, and the entity cannot sublease or exit, the excess cost may indicate impairment.

Reversal of Impairment

Unlike goodwill impairment, an impairment loss on an ROU asset can be reversed if the conditions that caused the impairment no longer exist. The reversal cannot exceed the carrying amount that would have been determined had no impairment been recognised (i.e., the original cost less accumulated depreciation).

Journal Entries

Initial Recognition (1 January 2026)

Dr  Right-of-use asset                    EUR 555,040
    Cr  Lease liability                              EUR 543,040
    Cr  Cash (initial direct costs paid)             EUR 5,000  [Note: debit to asset above]
    Cr  Provision for restoration                    EUR 15,000
    Dr  Cash (incentive received)           EUR 8,000

More precisely, the entries at commencement are:

Recognise the lease liability and base ROU asset:

Dr  Right-of-use asset          EUR 543,040
    Cr  Lease liability                    EUR 543,040

Capitalise initial direct costs:

Dr  Right-of-use asset          EUR 5,000
    Cr  Cash / Accounts payable            EUR 5,000

Capitalise restoration obligation:

Dr  Right-of-use asset          EUR 15,000
    Cr  Provision for restoration          EUR 15,000

Deduct lease incentive:

Dr  Cash / Receivable           EUR 8,000
    Cr  Right-of-use asset                 EUR 8,000

Net ROU asset after all entries: EUR 555,040

Monthly Depreciation (31 January 2026 onwards)

Dr  Depreciation expense        EUR 9,250.67
    Cr  Accumulated depreciation — ROU asset    EUR 9,250.67

Monthly Lease Payment (31 January 2026 onwards)

The lease payment is split between interest and principal. In the first month:

Interest = EUR 543,040 × (4% / 12) = EUR 1,810.13
Principal = EUR 10,000 − EUR 1,810.13 = EUR 8,189.87

Dr  Interest expense            EUR 1,810.13
Dr  Lease liability             EUR 8,189.87
    Cr  Cash                               EUR 10,000.00

ROU Asset vs Lease Liability: How They Diverge Over Time

At commencement, the ROU asset and lease liability start at different values (EUR 555,040 vs EUR 543,040 in our example). Even if they started at identical values, they would diverge immediately because they are measured using fundamentally different methods:

• The lease liability decreases via the effective interest method — each payment is split into interest (declining) and principal (increasing). The liability reduction accelerates over time.
• The ROU asset decreases via straight-line depreciation — the same amount each month.

Divergence Schedule (Selected Periods)

In the early years, the lease liability decreases more slowly than the ROU asset (because interest expense is higher and principal repayment is lower). In the later years, the liability catches up as interest costs decline. Both reach zero at the end of the lease term.

This divergence has implications for balance sheet presentation and financial ratios. The net lease position (ROU asset minus lease liability) shifts from positive to negative during the lease term, which can affect debt-to-equity ratios and other metrics that analysts monitor.

Remeasurement Impact on the ROU Asset

The ROU asset carrying amount is adjusted whenever the lease liability is remeasured. The most common triggers for remeasurement under IFRS 16 are:

1. Change in an Index or Rate (CPI-Linked Escalation)

European commercial leases frequently include rent escalation clauses linked to consumer price indices — the German VPI, French ILC/ILAT, Spanish IPC, or Dutch CPI. When the index changes, the future lease payments change, and the liability must be remeasured.

Remeasurement treatment: The lease liability is recalculated using the revised payments but the original discount rate. The difference between the old and new liability is added to (or subtracted from) the ROU asset.

Example: On 1 January 2027, the CPI adjustment increases monthly rent from EUR 10,000 to EUR 10,300. The lease liability is remeasured based on the new payment stream for the remaining 48 months at the original 4% discount rate. The increase in liability (approximately EUR 13,000) is added to the ROU asset.

2. Reassessment of a Lease Term Option

If the entity changes its assessment of whether it will exercise an extension or termination option, the lease liability is remeasured using a revised discount rate (the IBR at the date of reassessment). The corresponding adjustment goes to the ROU asset.

3. Lease Modification

A lease modification (e.g., adding floor space, extending the term by agreement) that is not accounted for as a separate lease results in a remeasurement of the lease liability. The adjustment is reflected in the ROU asset.

When the ROU Asset Reaches Zero

If a remeasurement would reduce the ROU asset below zero (for example, a significant reduction in the lease term), the excess is recognised immediately in profit or loss. The ROU asset cannot have a negative carrying amount.

Common Mistakes to Avoid

1. Forgetting restoration costs. Many entities calculate the ROU asset as simply the lease liability plus direct costs, omitting the estimated cost of dilapidations or make-good obligations. For European property leases, restoration provisions can be material — EUR 15,000 to EUR 50,000 or more for fitted-out office space.

2. Using the wrong depreciation period. The default is the shorter of the lease term or useful life. Some entities mistakenly use the useful life of the building (30–40 years) for a 5-year lease, dramatically understating annual depreciation.

3. Not testing for impairment when indicators exist. The fact that an entity has never impaired an ROU asset does not mean indicators are absent. Surplus space following headcount reductions, market rent declines, or planned relocations should all trigger a formal assessment.

4. Treating CPI remeasurement as a Day 1 adjustment. CPI-linked rent increases are remeasurement events, not Day 1 modifications. The revised payments are discounted at the original rate — not a new rate — and the adjustment flows through the ROU asset, not profit or loss.

5. Ignoring the divergence between ROU asset and lease liability. Assuming the two balance sheet items track each other leads to presentation errors. The ROU asset and liability must be tracked separately and can produce a net debit or credit position at any given reporting date.

6. Capitalising non-qualifying costs. Only incremental costs directly attributable to negotiating and arranging the lease qualify as initial direct costs. General overhead, allocation of internal staff time, and costs related to activities before the lease negotiation (e.g., site selection costs for multiple locations) are expensed as incurred.

7. Misapplying lease incentives. Lease incentives reduce the ROU asset at commencement. If the incentive is received after commencement (e.g., a rent-free period in months 1–6), the measurement at commencement still reflects the incentive — the lease liability is based on the full payment stream including zero-payment months.

Summary

The IFRS 16 ROU asset is more than just the lease liability on the other side of the balance sheet. Its initial measurement incorporates five distinct components, its depreciation follows a pattern that diverges from the liability's effective interest method, and it is subject to impairment testing under IAS 36. European entities with CPI-linked leases face additional complexity from annual remeasurement adjustments.

For accurate lease liability calculations that feed into the ROU asset, use our IFRS 16 lease liability calculator. For the complete liability calculation methodology, see our step-by-step lease liability guide. For entities reporting under UK GAAP rather than IFRS, see our FRS 102 ROU asset guide — the concepts are similar but the impairment framework and some measurement details differ.