Many businesses use some form of financing arrangement to acquire the assets they run on — vehicles, equipment, plant, property and more. These arrangements are commonly structured as hire purchase, finance leases or operating leases, and the way each is treated for accounting and for tax has a direct impact on annual reporting and compliance.
Over the last several years, accounting standards have changed how most of these arrangements appear on the balance sheet. Under IFRS 16 internationally, ASC 842 under US GAAP, and AASB 16 in Australia, many leases require the lessee to recognise a right-of-use (ROU) asset on the balance sheet, with a corresponding lease liability. The ROU asset is then depreciated (or amortised) over its useful life, or over the length of the lease where that is shorter.
Tax is a separate story. Each taxing authority sets its own rules, and the tax treatment of a lease often diverges from the accounting treatment. This article explains what a right-of-use asset is, whether it counts as a fixed asset, how it is accounted for, and how the tax treatment differs — including why the accounting and tax positions frequently don’t match.
What is a right-of-use asset?
A right-of-use asset represents a business’s right to use an underlying asset over the term of a lease, rather than outright ownership of it. When a lease is recognised on the balance sheet under IFRS 16, ASC 842 or AASB 16, two things are recorded:
- a right-of-use asset, reflecting the value of the right to use the item over the lease term; and
- a lease liability, reflecting the obligation to make the lease payments.
The ROU asset is then depreciated or amortised over the lease term or useful life, depending on the standard, lease classification and facts of the arrangement, while the liability unwinds as payments are made.
Is a right-of-use asset a fixed asset?
A right-of-use asset is not always a fixed asset in the traditional legal-ownership sense, but it is commonly presented and managed like one for accounting purposes — because the business controls the right to use the underlying asset over the lease term.
Here’s the distinction. A traditional fixed asset (also called property, plant and equipment) is an item the business owns and uses over the long term. A right-of-use asset is not owned — it represents the right to use a leased item for the duration of the lease, arising from the business’s control over that use. The standards treat it separately because the business holds a right of use rather than legal title.
That said, once a ROU asset is on the balance sheet, it behaves very much like a fixed asset:
- it is capitalised rather than expensed as it’s paid for;
- it sits on the balance sheet as a non-current asset;
- it is depreciated or amortised over its useful life or lease term; and
- it is often managed in or alongside the fixed asset register, so finance teams can track depreciation, carrying values and disclosures in one place.
So for day-to-day accounting and asset management, a right-of-use asset is treated as part of the fixed-asset base. The important nuance — and the reason the standards give it a separate name — is that it reflects a right to use, not ownership, which matters for how leases are classified, remeasured and disclosed.
Types of fixed-asset leases
Before looking at treatment, it helps to break these arrangements into categories. The main types relevant to most businesses are:
- Hire purchase assets — where title of the asset transfers to the lessee at the end of the arrangement.
- Finance lease assets — where there is no expectation, or some degree of uncertainty, over whether title will pass to the lessee when the lease concludes.
- Operating leases — leases that do not transfer ownership-style risks and rewards in the same way as finance leases or hire purchase arrangements. Under modern lease accounting standards, many operating leases are still recognised on the balance sheet by lessees, although the accounting pattern can differ by standard.
The classification matters because it influences both how the arrangement is recognised and, in several jurisdictions, how it is treated for tax.
Accounting treatment
Under the current standards, the accounting treatment for most right-of-use assets follows the same broad pattern: the asset is capitalised and depreciated over time, with a corresponding lease liability recognised on the balance sheet.
When a business enters into a lease, there is normally a schedule of payments that shows the total amount payable on each date, split between capital repayments and interest on the outstanding balance. Where a payment schedule isn’t provided, one can be derived from the interest rate specified in the contract.
There are then two types of cost to account for — at the start of the lease and throughout its life:
At the start of the lease
- The lease liability is generally measured based on the present value of the future lease payments.
- The right-of-use asset is initially measured based on the lease liability, adjusted for items such as initial direct costs, lease payments made before or at commencement, restoration obligations and lease incentives, where applicable.
- Deposits, incentives and trade-in values may affect the initial measurement depending on the terms of the arrangement and the accounting standard applied.
During the life of the lease
- The asset is depreciated through normal depreciation journal entries.
- Interest is recognised in the P&L as it accrues, with a corresponding liability on the balance sheet until it is paid.
- As payments are made, they are applied against the interest due and against reducing the capital outstanding.
Getting these entries right — and keeping them consistent across a large asset register as leases are modified, extended or ended early — is where lease accounting becomes time-consuming to manage in spreadsheets.
Right-of-use asset tax treatment
This is where many finance teams get caught out. Recognising a right-of-use asset on the balance sheet is an accounting outcome driven by IFRS 16, ASC 842 or AASB 16. It does not automatically determine how the arrangement is treated for tax.
Tax rules are set independently by each jurisdiction, and they frequently diverge from the accounting position — creating book-tax differences that have to be tracked separately. In broad terms:
Australia and New Zealand
In Australia and New Zealand, the treatment can differ depending on whether the arrangement is closer to hire purchase or a finance lease:
- Hire purchase assets are treated under the same principles as the accounts: the assets are capitalised for tax and depreciated under normal rules, and a tax deduction is available for the interest components of the payments made (note there is a restriction on this where the leased asset is a luxury car).
- Finance lease assets are not capitalised for tax, which means there is a mismatch between the tax and accounts positions on the balance sheet, no tax depreciation is available on the asset, and instead tax deductions are permitted for the payments made under the terms of the lease.
United States (general principle)
For US tax purposes, the ASC 842 right-of-use asset is generally a book accounting concept rather than a tax asset in itself. Tax treatment depends on how the lease is characterised under tax rules, and this can create book-tax differences. Businesses should confirm the treatment against IRS guidance or professional tax advice.
United Kingdom (general principle)
In the UK, tax treatment depends on the lease type, the applicable capital allowances rules and the facts of the arrangement. Recognising a right-of-use asset for accounting purposes does not automatically settle the tax treatment.
The common thread across all jurisdictions: the accounting treatment and the tax treatment are set separately, and reconciling the two is one of the reasons lease and fixed-asset records need to be maintained carefully.
Accounting treatment vs tax treatment: the key differences
| Accounting (IFRS 16 / ASC 842 / AASB 16) | Tax (jurisdiction-specific) | |
|---|---|---|
| On the balance sheet? | ROU asset + lease liability recognised for most leases | Depends on lease classification under local tax law |
| What’s deducted / expensed? | Broadly, depreciation of the ROU asset plus interest on the liability (the exact P&L pattern varies by standard and lease type) | Either lease payments, or depreciation plus interest — set by local rules |
| Who decides the rules? | Accounting standard-setters | Each taxing authority independently |
| Result | A broadly consistent on-balance-sheet recognition model across standards | Frequent divergence, creating book-tax differences |
The practical takeaway is that a right-of-use asset can look settled on the accounting side and still require separate tracking for tax. Keeping the accounting and tax positions reconciled is one of the ongoing challenges of managing leased assets.
Right-of-use assets, lease liabilities and depreciation
For finance and accounting teams, a right-of-use asset rarely sits in isolation. Once a lease is recognised, several moving parts need to be tracked together over its life:
- the right-of-use asset itself, held in the asset record alongside owned fixed assets;
- the depreciation or amortisation of that asset over the lease term or useful life;
- the lease liability, representing the outstanding obligation to make payments;
- the interest accruing on that liability, recognised as it arises;
- the journal entries that post depreciation, interest and payments in each period; and
- the reporting and disclosures that pull these together for the financial statements.
Because these elements interact — a lease modification, for example, can change the liability, the asset value, the depreciation profile and the disclosures all at once — they are far easier to keep aligned when the asset register, depreciation schedules and lease records are maintained together rather than across separate spreadsheets.
If your team manages fixed assets and lease-related records together, it is worth reviewing whether your asset register, depreciation schedules and lease records are aligned.
Other issues
There are far more complexities around leased assets than any single article can cover — lease modifications, early terminations, extensions, indexation and CPI-linked payments, and changes to leases part-way through their lives all add layers of calculation.
If you’re weighing up how lease accounting sits alongside your broader asset records, our overview of lease accounting is a good next read, and the difference between the current and previous US standards is covered in ASC 840 vs ASC 842. US readers can also see our US fixed asset and lease accounting solutions.
