A right of use asset refers to an intangible asset recognized by a company under the Accounting Standards Codification (ASC) 842, which governs the accounting treatment of leases. This accounting standard was issued by the Financial Accounting Standards Board (FASB) to bring transparency and accuracy to lease reporting. A right of use asset represents the lessee’s right to use a leased asset over the lease term.
Typically, a right of use asset arises when a lease agreement is in place, granting the lessee the right to control the use of a specific asset. The example of a right of use asset can be found in various industries, such as real estate, manufacturing, transportation, and technology.
Let’s consider a practical example to illustrate the concept of a right of use asset. Suppose Company A enters into a lease agreement with Company B for the use of a warehouse space. The lease agreement states that Company A has control over the warehouse for a period of five years. As per ASC 842, Company A is required to recognize a right of use asset on its balance sheet to reflect its control over the warehouse.
To calculate the initial measurement of the right of use asset, Company A would consider various components, such as lease payments, lease term, incentives, and other costs directly related to obtaining the right to use the asset. These components would be used to determine the present value of future lease payments, which would then be recognized as the initial measurement of the right of use asset.
Once the right of use asset is recognized, it is subject to depreciation or amortization over the lease term. The method of depreciation or amortization would depend on the nature of the underlying asset. For example, if the right of use asset relates to a building, straight-line depreciation may be applied. On the other hand, if the right of use asset relates to equipment, it may be subject to accelerated depreciation.
Throughout the lease term, the carrying value of the right of use asset may be subject to impairment testing if certain events or circumstances indicate a potential impairment. Impairment may occur if there is a significant change in the lease terms, the economic environment, or the lessee’s intended use of the leased asset.
Upon the expiration or termination of the lease, the right of use asset is derecognized from the balance sheet, and any remaining lease liability is settled. Any difference between the carrying value of the right of use asset and the settlement amount is recognized as a gain or loss in the income statement.
In conclusion, a right of use asset is a vital component of lease accounting under ASC 842. It reflects the lessee’s right to use a leased asset over the lease term. It is measured initially at the present value of future lease payments and subject to depreciation or amortization over the lease term. Companies across various industries, such as real estate, manufacturing, transportation, and technology, encounter examples of right of use assets in their day-to-day operations. Proper recognition and measurement of right of use assets provide transparency and accuracy in financial reporting, aiding stakeholders in making informed decisions.
