Record right-of-use asset depreciation (Preview)
Important
Some or all of the functionality noted in this article is available as part of a preview release. The content and the functionality are subject to change. For more information about preview releases, see Service update availability.
For leases that are recognized on an organization's balance sheet, the right-of-use (ROU) asset is amortized on a monthly basis. This article explains how to create the journal entry for the amortization. The amortization debits the expense ledger account and credits the accumulated depreciation ledger account, based on the setup of your posting profile and the lease type. These entries can be created for each lease, or they can be created for multiple leases by using the batch journal functionality.
Asset depreciation schedule
On the Lease summary page, select a lease. Then select Books > Asset depreciation schedule to open the Asset depreciation schedule page.
The ROU asset depreciation expense journal entry is based on the amount in the Depreciation Expense column. For an example of the guidance for accounting standard compliance, see the Calculation of ROU asset amortization expense for finance leases section later in this article.
Select the period of depreciation, and then select Create journal. You receive a message that states that the journal that will be used to record depreciation was created.
Select Journals > Asset leasing journals to open the Asset leasing journal page, where you can view the depreciation expense journal entry that was created.
The system locks certain financial fields from being edited to prevent any variances between the transactions and the schedules. Some fields that are locked include: Account, Amounts, Financial dimensions, Currency, and Transaction type. Additionally, you won't be able to add or delete journal entry lines in any Asset leasing journal entries, as this might cause variances between the schedules and the transactions.
Select the journal entry, and then select Post to record the depreciation entry to General ledger.
Calculation of ROU asset amortization expense for operating leases
The depreciation expense of an operating lease is calculated as the difference between the monthly straight-line lease expense and the monthly interest expense on the lease liability, in accordance with Accounting Standards Codification Topic 842 (ASC 842), which is the standard in Generally Accepted Accounting Principles in the US (US GAAP). The straight-line lease expense is calculated as the sum of all lease payments divided by the lease term in months. (The sum of lease payments includes any prepayments, initial direct costs, dismantling costs, and lease incentives.) The following table shows an example of the amortization expense for an operating lease.
Example of ROU asset amortization expense for operating leases
| Field | Value |
|---|---|
| Payment amount | 1,000 |
| Payment frequency | Monthly |
| Lease term (months) | 24 |
| Total lease payments | 24,000 |
| Incremental borrowing rate | 5% |
| Annuity type | Annuity due |
| Compounding Interval | Monthly |
| Present value of future minimum lease payments | 22,888.87 |
As was previously mentioned, the straight-line lease expense is calculated as the sum of all payments divided by the lease term. The system automatically calculates the monthly interest expense on the liability amortization schedule. The interest expense is calculated by using the effective interest rate method. The system will use the straight-line lease cost to subtract the interest expense for each month. The value is used to reduce the ROU asset.
| Month | Straight-line lease cost | Interest expense | Calculation of ROU asset amortization expense |
|---|---|---|---|
| 1 | (24,000 ÷ 24) = 1,000.00 | (22,888.87 – 1,000) × (5% ÷ 12) = 91.20 | 1,000 – 91.20 = 908.80 |
| 2 | (24,000 ÷ 24) = 1,000.00 | (21,980.08 – 1,000) × (5% ÷ 12) = 87.42 | 1,000 – 87.42 = 912.58 |
| 3 | (24,000 ÷ 24) = 1,000.00 | (21,067.49 – 1,000) × (5% ÷ 12) = 83.62 | 1,000 – 83.62 = 916.39 |
Note
According to ASC 842, the depreciation of the ROU asset for an operating lease is classified as a lease expense on the income statement. For visibility, Asset leasing describes the entry as the depreciation of the ROU asset. However, the debit entry should be assigned to an operating lease expense account, and the credit entry should be assigned directly to the ROU asset for the operating lease. Nevertheless, in the lease parameters, you can specify that credit entries should be made to an accumulated depreciation account for operating ROU assets.
If the lease is classified as an operating lease, the monthly depreciation after impairment will be calculated using straight-line depreciation.
Calculation of ROU asset amortization expense for finance leases
For leases that have a finance classification, the system calculates the ROU asset amortization on a straight-line basis. Therefore, the depreciation expense will be the same for each month.
In accordance with International Financial Reporting Standard 16 (IFRS 16) and ASC 842, the asset will be amortized over either the lease term or the asset's useful life, whichever is less. Additionally, if the Transfer of ownership parameter is turned on for the lease, the lease will automatically be depreciated over the asset's useful life.
Example of ROU asset amortization expense for finance leases
| Field | Value |
|---|---|
| Beginning right-of-use asset balance | 22,889.87 |
| Lease term (months) | 24 |
| Asset useful life (months) | 36 |
| Month | Right-of-use asset amortization expense |
| 1 | 22,889.87 ÷ 24 = 953.74 |
| 2 | 22,889.87 ÷ 24 = 953.74 |
| 3 | 22,889.87 ÷ 24 = 953.74 |
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