What Is A Right Of Use Asset And Why It is Essential
What Is A Right Of Use Asset
The right of use asset is a lease that allows someone to use an asset over a lease life. The amortization period is started from the commencement of the lease till the end of the lease contract. When the lease contract is made there is an option to purchase the asset, in this case, an asset is amortized over the asset’s useful life.
The right-of-use asset is calculated as the initial amount or value of the lease liability plus any amount paid to the lessor before commencing the lease contract plus other direct costs less any incentive received.
If the right-of-use asset is determined on the bases of impairment then the impairment cost is instantly recorded which reduces the carrying amount of an asset. When impairment is deducted from the carrying amount add amortization expense for the period to know the right-of-use asset value.
Right of use asset or ROU is an essential component of an accounting standard that represents the right of use of a leased asset over the lease contract. The right-of-use asset consists of various components which are the followings:
Lease Liability: it represents the present value of the future lease payment. It is recorded in the balance sheet as a liability associated with the lease agreement.
Initial Direct Cost: the cost incurred for obtaining a lease agreement such as legal fees or commissions.
Lease Payments: total payment of a lease contract over a lease term.
Lease Modification and Impairment Loss: lease modification is the changes in the lease term and impairment loss means when an asset value is decreased or the lease term is changed then impairment loss is adjusted with the carrying amount of an asset.
Why Right Of Use Asset Is Important
Following are the major reasons why the right of use asset is very important for a business.
- It helps a business to make the financial statement accurate and transparent as per financial reporting standards
- Having knowledge about lease contracts a company can make an informed decision by assessing its lease commitments
- By tracking the right of use asset a company can manage its assets more effectively
- Recognizing the right of use assets by following proper accounting standards helps a company to present true and fair financial statements to the investors and shareholders
- Presenting information about ROU in the financial statements increases the confidence of investors and creditors, etc.
How To Calculate The Right Of Use Asset
FAQs
Standards that describe the right of use asset?
ASC 842, GASb 87, and IFRS 16 are the accounting standards that describe the right of use asset and other necessary guidelines related to the lease.
What does ROU mean?
ROU stands for right of use asset which is a very necessary concept in lease accounting that states how assets can be used over a lease contract and period.
Is the right of use asset an asset?
Right of use asset is considered a long-term asset in the balance sheet that is amortized over a lease contract.