Definition
Under ASC 842, a lessee recognizes a right-of-use (ROU) asset for its right to use the leased asset over the lease term. The ROU asset is measured at commencement as the initial lease liability, plus lease payments made before commencement and initial direct costs, less lease incentives received. Subsequent measurement depends on classification: finance leases amortize the asset straight line (generally) with separate interest expense, while operating leases produce a single straight-line lease cost.
Why it matters in an audit or review
The ROU asset and lease liability put leases on the balance sheet, which affects covenants and ratios. Auditors test completeness of the lease population, lease term and payment inputs, the discount rate, and the impairment evaluation of the ROU asset under ASC 360.
Example
(Illustrative) Five-year office lease, annual payments of $60,000 in arrears, discount rate 6%. Present value is $60,000 x 4.2124 (annuity factor, 5 years at 6%), about $252,700. With no incentives or initial direct costs:
Dr Right-of-use asset 252,700 Cr Lease liability 252,700
Common mistakes
- Missing embedded leases in service contracts.
- Excluding option periods that are reasonably certain to be exercised.
- Forgetting to impair an ROU asset on a vacated space.
Sources
- FASB ASC 842-20-30 (initial measurement of the right-of-use asset and lease liability)
- FASB ASC 842-20-25 and 842-20-35 (subsequent measurement; impairment under ASC 360)
- AICPA, AU-C Section 540, Auditing Accounting Estimates and Related Disclosures
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error