Is a Right-of-Use Asset Current or Noncurrent?
Clarify the balance sheet classification of Right-of-Use assets. Learn whether these assets are typically current or noncurrent in financial reporting.
The introduction of new accounting standards, specifically ASC 842 in the United States and IFRS 16 internationally, significantly changed how companies report lease agreements on their financial statements. These standards moved many leases from off-balance-sheet arrangements to on-balance-sheet recognition. This shift requires companies to identify and record a “Right-of-Use” (ROU) asset and a corresponding lease liability. The aim of these changes is to provide greater transparency into an organization’s financial obligations and the assets it controls.
Defining Right-of-Use Assets
A Right-of-Use (ROU) asset represents a lessee’s contractual right to control the use of an identified asset for a period of time. This concept is a core component of modern lease accounting standards, including ASC 842 and IFRS 16. Unlike prior accounting practices where many operating leases remained off the balance sheet, these new standards mandate the recognition of this asset.
The ROU asset does not signify ownership of the underlying asset itself, but rather the right to obtain economic benefits from its use. For instance, if a company leases office space, vehicles, or specialized equipment, the ROU asset reflects its right to utilize that property or machinery for the lease term.
The initial value of an ROU asset is derived from the initial measurement of the lease liability. These adjustments can include any lease payments made to the lessor before or at the commencement date of the lease, initial direct costs incurred by the lessee to secure the lease, and any lease incentives received from the lessor.
Classifying Right-of-Use Assets
Right-of-Use assets are classified as noncurrent assets on a company’s balance sheet. This classification reflects the nature of these assets, as they represent a right to use an underlying asset over a period that typically extends beyond one year.
Similar to property, plant, and equipment (PP&E), ROU assets are subject to amortization over their useful life. The amortization period is typically the shorter of the lease term or the useful life of the underlying asset. This systematic reduction of the asset’s value reflects the consumption of the economic benefits embodied in the right to use the asset over time.
While the related lease liability associated with an ROU asset is split into current and noncurrent portions, the ROU asset itself is predominantly presented as a long-term asset. The asset’s value diminishes over the lease term through regular amortization expense.
Certain short-term leases, typically those with a lease term of 12 months or less, may not result in the recognition of an ROU asset on the balance sheet. Accounting standards provide an election for lessees to expense these short-term lease payments on a straight-line basis over the lease term.
Understanding the Related Lease Liability
Concurrently with the recognition of an ROU asset, a corresponding lease liability is established on the balance sheet. This liability represents the lessee’s financial obligation to make lease payments over the lease term. It is initially measured as the present value of the lease payments that are not yet paid at the lease commencement date.
Unlike the ROU asset, the lease liability is explicitly bifurcated into both current and noncurrent portions. The current portion of the lease liability includes all lease payments that are due within the next 12 months from the balance sheet date.
The noncurrent portion of the lease liability encompasses all lease payments that are due beyond the next 12 months. This distinction provides financial statement users with a clear understanding of the company’s long-term lease commitments. As lease payments are made, both the ROU asset and the lease liability are systematically reduced, reflecting the diminishing right to use the asset and the reduction in the outstanding payment obligation.
The calculation of the lease liability involves discounting future lease payments using a discount rate. This present value calculation ensures that the liability reflects the time value of money.
Balance Sheet Presentation of Right-of-Use Assets and Lease Liabilities
The presentation of Right-of-Use assets and their corresponding lease liabilities on the balance sheet is a direct outcome of the updated lease accounting standards. ROU assets are typically displayed within the noncurrent assets section of the balance sheet. Companies have some flexibility in their presentation, either showing ROU assets as a separate line item or combining them with other long-term assets such as property, plant, and equipment, provided appropriate disclosures are made in the financial statement notes.
For lease liabilities, the distinction between current and noncurrent portions is a requirement for classified balance sheets. The current portion, representing payments due within the next year, is presented within current liabilities. This placement helps users assess the company’s short-term liquidity and obligations.
Conversely, the noncurrent portion of the lease liability, which includes payments due beyond one year, is presented within noncurrent liabilities. This separation provides insight into the long-term financial commitments arising from lease agreements. This clear presentation of both the asset and liability components of leases enhances the transparency of a company’s financial position, providing a more complete picture of its resources and obligations.