Right-of-Use (ROU) Asset — Definition
In real estate and lease accounting, a Right-of-Use (ROU) asset is the lessee’s recognized economic right to use a specified physical asset (for example, office space, retail premises, or equipment) for the lease term. Under current standards such as ASC 842 (U.S. GAAP), IFRS 16 (international), and GASB 87 (governmental), lessees record an ROU asset on the balance sheet together with a corresponding lease liability representing the present value of future lease payments.
Core concept
- The ROU asset is treated as an intangible asset that represents the contractual right to use an identified asset without transferring ownership.
- Initial measurement = present value of future lease payments + initial direct costs (e.g., legal fees) − lease incentives or credits from the lessor.
- The lessee also records a lease liability equal to the discounted future lease payments; the liability is reduced over time as payments are made and interest is recognized.
- The ROU asset is amortized (similar to depreciation) over the lease term, unless ownership transfers at the end of the lease or the asset’s useful life justifies a different period.
How ROU assets apply in real estate
- Office leases — Companies leasing offices record an ROU asset that reflects the right to occupy the space for the contract term, bringing many previously off‑balance-sheet leases onto the balance sheet.
- Retail and industrial — Retail chains and industrial operators recognize ROU assets for store or warehouse leases, affecting metrics like asset turnover and leverage.
- Multifamily/commercial property operations — Property managers and lessees report ROU assets and liabilities, which can influence borrowing capacity and portfolio analysis.
- Equipment and vehicles — The same accounting applies to leased vehicles, machinery, and IT equipment in addition to real property.
- Leasehold improvements — ROU assets sit alongside leasehold improvements (which are accounted for separately); see leasehold improvements for more details.
Example (five-year office lease)
Imagine a five-year office lease with monthly payments that escalate 3% annually. At lease commencement the lessee:
- Calculates the present value of expected lease payments using its incremental borrowing rate (e.g., 5%).
- Recognizes that present value as both the ROU asset and the lease liability.
- Adds any initial direct costs (legal or broker fees) to the ROU asset and reduces the ROU asset by landlord incentives (e.g., tenant improvement allowances).
- Amortizes the ROU asset over the lease term while accounting for interest expense on the lease liability, producing the total lease expense impact on the income statement.
Why ROU assets matter
- Greater financial transparency — Leases no longer hide obligations off-balance-sheet; investors and lenders see the economic commitments.
- Impact on ratios — Reporting ROU assets and liabilities changes leverage and coverage ratios and can affect loan covenants and borrowing costs.
- Better decision-making — Clearer accounting helps companies compare lease vs. buy choices, negotiate lease terms, and manage portfolio commitments.
Quick lessee checklist
- Identify lease commencement and the identified asset.
- Determine lease term (include renewal/termination options that are reasonably certain).
- Select the discount rate (incremental borrowing rate or rate implicit in the lease, when available).
- Include initial direct costs and adjust for any incentives.
- Record initial ROU asset and lease liability; account for amortization and interest going forward.
- Remeasure when lease modifications, changes in term, or changes in payments occur.
Common questions
Is an ROU asset the same as ownership? No. An ROU asset reflects the right to use an asset under contract; title/ownership remains with the lessor unless the lease includes a transfer of ownership.
How long is the ROU asset amortized? Typically over the lease term, unless ownership transfers to the lessee or the asset’s useful life warrants a different period.
Do short-term leases require ROU recognition? Accounting standards generally allow a short-term lease exemption (commonly leases of 12 months or less) where a lessee can elect not to recognize an ROU asset and lease liability — check the specific standard (ASC 842, IFRS 16) and company policy.
Will ROU assets affect loan covenants? Yes. Recognizing ROU assets and liabilities usually increases reported assets and liabilities and can change leverage ratios; consult your lender and accountant when negotiating or measuring covenants.
Bottom line: In real estate, a Right-of-Use (ROU) asset puts the economic right to occupy or use leased property on the lessee’s balance sheet and pairs it with a lease liability representing future payment obligations—improving transparency but changing financial metrics and covenant considerations.
