Over what period a right-of-use asset is depreciated
Why a right-of-use asset is depreciated over the shorter of useful life and lease term, what changes when ownership passes, and how to check the charge.
By Achekam · · 5 min read · For Accountants & audit firms in South Africa, Nigeria, Kenya
A transport company leases two kinds of truck. The first kind it returns to the lessor at the end of each lease. The second kind it keeps: the agreement transfers ownership once the last instalment is paid. Both sit on the statement of financial position as right-of-use assets, both were recognised the same way on day one, and the bookkeeper depreciates both over the lease term. One of those is wrong.
The period over which a right-of-use asset is depreciated is a small decision with a large effect on each year's charge. It turns on two questions: how long will the client use the asset, and does the client end up owning it? This article works through both, and through checking the charge that results.
Shorter of useful life and lease term
IFRS 16 introduced a single lessee accounting model. It requires a lessee to recognise assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value, and to recognise a right-of-use asset representing its right to use the leased asset.
ACCA explains the default depreciation rule: a right-of-use asset is depreciated over the shorter of the asset's useful life and the lease term. The logic is simple. The client's right to use the asset ends when the lease ends, so the right cannot be worth anything beyond that date. And if the asset itself wears out before the lease ends, the right to use it is worth nothing once it has.
In practice, for most property leases the lease term is the shorter, because buildings outlast the leases over them. For some equipment the useful life can be shorter than the lease, for example a laptop fleet leased for longer than the machines will realistically stay in service. Either way, compare the two and record which was used and why.
When title transfers: useful life
ACCA adds the exception: if title transfers at the end of the lease, the right-of-use asset is depreciated over its useful life.
That is the transport company's second kind of truck. Because the company will own the truck once the agreement ends, the right-of-use asset is in substance the truck itself, and the company will go on using it after the last payment. Depreciating it over the lease term would write the asset off too quickly and leave a fully depreciated truck in daily use.
Read the agreement for the ownership clause. Instalment-style agreements on vehicles and equipment often transfer title on final payment, sometimes for a nominal amount. An option to buy at the end raises a similar question, and IFRS 16 sets out how such an option affects the period; read it before deciding. Record the clause relied on in the working papers.
Renewal options and the lease term
The lease term is not always the contract's initial period. A shop lease with a right to renew, or a right to end the lease early, may have a different term for accounting purposes, depending on how IFRS 16's test for options applies to the client's circumstances. The term used to measure the lease liability is the term used in the shorter-of comparison, so the two decisions should be made together and documented in one place.
Watch for changes. If the client decides during the lease to exercise a renewal it had not previously expected to take up, or to leave early, the term changes, and with it the remaining depreciation period. Keep the lease file under review each year rather than fixing the period once at commencement.
Agreeing the charge in the trial balance
Achekam lets staff keep a client's lease register under IFRS 16 or IFRS for SMEs Section 20. Lease terms can be read from the contract into an AI draft, but that draft is not used until a person confirms it, and every number the AI reads must appear in the contract text. Confirm the term and the ownership clause in particular, since they decide the depreciation period.
Achekam does not calculate depreciation. It presents the depreciation in the trial balance and flags when the charge does not agree with the movement in accumulated depreciation. For right-of-use assets, that means the client or the preparer works out the charge, using the period decided above, and checks it against what the trial balance shows. If the charge is wrong, staff post a year-end adjusting entry in the Studio; an entry that later proves wrong is reversed with a record of who did it and why, never deleted.
A practical check for each lease:
- Confirm the term and any options from the signed lease.
- Confirm whether title transfers at the end.
- Estimate the useful life of the underlying asset.
- Choose the period: useful life if title transfers, otherwise the shorter of useful life and lease term.
- Recompute the year's charge and agree it to the trial balance.
- Clear any flag on the accumulated depreciation movement before the draft is reviewed.
The opening amounts on which this depreciation is based are covered in first measuring a right-of-use asset.
Depreciation policy wording for leased assets
The depreciation policy should say how right-of-use assets are depreciated in terms specific to the client. A useful form is: right-of-use assets are depreciated on a straight-line basis over the shorter of the lease term and the useful life of the underlying asset, except where ownership transfers to the company at the end of the lease, in which case they are depreciated over the useful life. Name the classes of leased asset and give the ranges of periods used, so the reader can see the effect.
If the client uses a method other than straight line, say so and say why. Keep the right-of-use policy next to the policy for owned assets, so the reader can compare them; the wider presentation of depreciation is covered in depreciation in the statements.
ACCA's technical article on IFRS 16 explains how a lessee recognises a right-of-use asset and lease liability, with worked examples. Before this year's review, sort every lease the client holds into two piles, those it returns and those it keeps, and check that each pile is depreciated on the right basis.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
