Since the introduction of lease accounting under AASB 16, Australian businesses have had to rethink how they recognise, measure and depreciate assets that arise from leasing arrangements. One area that continues to create confusion for directors, CFOs, finance managers and business owners is the depreciation period for right‑of‑use (ROU) assets — and why it can be different from the depreciation period applied to owned property, plant and equipment (PPE).

At Business Avengers, we regularly see Australian SMEs, not‑for‑profits and growing corporates make incorrect assumptions when accounting for leased assets. These assumptions can lead to misstated financial statements, compliance risks, poor decision‑making and surprises during audits.

This article explains, in plain Australian English, how depreciation of right‑of‑use assets works under Australian Accounting Standards, why it differs from owned PPE, and what practical steps Australian businesses should take to get it right.

Understanding Right‑of‑Use Assets Under AASB 16

What Is a Right‑of‑Use Asset?

Under AASB 16 Leases, when a business enters into a lease (with limited exceptions), it recognises:

• A right‑of‑use asset, representing the right to use the underlying asset, and
• A lease liability, representing the obligation to make lease payments.

This applies to common Australian business leases such as:

• Commercial office space
• Retail premises
• Warehouses and factories
• Vehicles and fleets
• Plant and machinery
• Specialised equipment

The key concept is that the business does not own the asset itself. Instead, it owns the right to use that asset for a defined period.

How Owned Property, Plant and Equipment Is Depreciated

Before diving into ROU assets, it is important to revisit how owned PPE is depreciated in Australia.

Under AASB 116 Property, Plant and Equipment, depreciation is based on:

• The asset’s useful life to the entity.
• The pattern in which economic benefits are consumed.
• Residual value at the end of its useful life.

For example:

• A business might depreciate owned machinery over 10 years.
• A building may be depreciated over 40 years.
• Vehicles may be depreciated over 5 to 8 years.

The depreciation period reflects how long the business expects to benefit from owning the asset, not contractual terms.

Why Right‑of‑Use Assets Are Different

The Core Difference

A right‑of‑use asset is not depreciated based on the physical asset’s useful life. Instead, it is depreciated over:

• The lease term, or
• The asset’s useful life, if ownership transfers or a purchase option is reasonably certain to be exercised

This distinction is critical.

Determining the Lease Term in Australia

When applying AASB 16, the lease term isn’t just about what’s written on the first page of the contract. Instead, it reflects how long the business is realistically expected to use the asset, based on both contractual rights and management’s intentions.

Lease Term Includes:

To arrive at the correct lease term, you need to look beyond the base period and consider how likely certain options are to be used in practice.

The non-cancellable period of the lease
This is the minimum period the lessee is legally committed to the lease and cannot walk away from without significant penalty. It forms the starting point of the lease term calculation.

Periods covered by extension options where the lessee is reasonably certain to exercise them
If the business has strong reasons to continue using the asset—such as operational dependence or high relocation costs—these extension periods should be included in the lease term.

Periods covered by termination options where the lessee is reasonably certain not to exercise them
If terminating the lease early would be impractical or harmful to the business, those periods are effectively treated as part of the lease term.

Practical Australian Example

Let’s bring this to life with a real-world scenario many Australian SMEs can relate to.

An Australian SME signs a commercial property lease with:

• An initial term of 5 years

• Two 5-year extension options

At face value, it might look like a 5-year lease. However, management expects to stay for at least 10 years because of:

• A significant fit-out investment that would be costly to abandon
  
• The strategic importance of the location
  
• Long-term business growth plans tied to that site
  

Because management is reasonably certain they will exercise at least one extension option, the lease term used for accounting purposes may be 10 years instead of 5. This longer lease term directly affects how the right-of-use asset is depreciated and how the lease liability is measured—making it a critical judgement under AASB 16.

Depreciation Period for Right‑of‑Use Assets

General Rule

A right‑of‑use asset is depreciated from the commencement date over the shorter of:

• The lease term, or
• The useful life of the underlying asset

Exception

If the lease transfers ownership of the underlying asset to the lessee by the end of the lease term, or if there is a purchase option that the lessee is reasonably certain to exercise, then the ROU asset is depreciated over the asset’s useful life.

Why the Depreciation Period May Be Shorter Than Owned PPE

This is where many Australian businesses go wrong.

Example: Leased vs Owned Equipment

• Owned manufacturing equipment may have a useful life of 15 years.
• The same equipment leased for 5 years (with no purchase option) results in a right‑of‑use asset depreciated over 5 years.

Even though the physical asset lasts longer, the business only controls it for the lease term.

Common Australian Scenarios

Commercial Property Leases

Most Australian commercial property leases do not transfer ownership. As a result:

• ROU assets are depreciated over the lease term.
• This may be significantly shorter than a building’s useful life.

Vehicle and Fleet Leasing

• Novated leases and operating‑style vehicle leases typically result in depreciation over 3–5 years
• Owned vehicles may be depreciated over a longer period

Plant and Equipment Leasing

• Hire purchase or finance leases with ownership transfer may allow depreciation over useful life
• Pure leases without ownership transfer do not

Impact on Financial Statements

Adopting shorter depreciation periods under AASB 16 doesn’t just affect one number — it flows through your entire set of financial statements, influencing profitability, asset values, and key performance metrics.

Profit and Loss

When depreciation periods are shorter, the expense is recognised more aggressively upfront. This leads to higher annual depreciation charges in the early years of a lease, which in turn reduces reported profits during those initial periods, even though cash outflows remain unchanged.

Balance Sheet

On the balance sheet, the Right-of-Use (ROU) asset reduces more quickly due to accelerated depreciation. At the same time, lease liabilities follow a different pattern — they unwind separately through interest expense and principal repayments, which means assets and liabilities don’t decline in a straight line together.

Key Ratios

These accounting changes also shift how performance ratios look. EBITDA often improves under AASB 16 because lease expenses are replaced by depreciation and interest. However, net profit may still fall in the early years due to front-loaded expenses, and asset turnover ratios can change as the asset base reduces faster.

Tax vs Accounting Depreciation in Australia

One of the most common areas of confusion for Australian businesses is understanding that depreciation is treated differently for financial reporting and for tax purposes. While both aim to reflect the use of assets over time, they are governed by entirely different rules and objectives.

Accounting depreciation is calculated in line with AASB standards, focusing on accurately representing an asset’s useful life and value in the financial statements. This helps stakeholders understand the true financial position and performance of the business.

Tax depreciation, on the other hand, is determined by Australian tax law and ATO guidance, with the primary aim of calculating taxable income. The rates, methods, and timing can differ significantly from accounting treatment.

Because of these differences, businesses often experience temporary differences between accounting profit and taxable profit. These differences commonly give rise to deferred tax assets or liabilities, which must be identified and recorded correctly to avoid misstatements.

This is why professional advice is essential—to ensure depreciation is aligned across compliance, reporting, and tax planning, while avoiding errors that could impact cash flow or attract ATO scrutiny.

Common Mistakes We See in Australian Businesses

Even well-run Australian businesses often trip up on lease accounting, not because of intent, but due to legacy habits and unclear judgement calls. These issues usually stay hidden until an audit, funding discussion, or due-diligence review brings them to light.

Let’s know them.

Depreciating ROU assets over the useful life instead of the lease term

This is a very common carry-over from fixed asset accounting. Under AASB 16, ROU assets should generally be depreciated over the lease term, not the asset’s economic life. Getting this wrong can materially overstate assets and distort profit trends.

Ignoring extension options when determining lease term

Many businesses default to the base lease period and overlook extension options that are “reasonably certain” to be exercised. This leads to understated lease liabilities and ROU assets. Auditors and lenders often flag this as a judgement weakness.

Applying tax depreciation rules to accounting records

Tax and accounting serve different purposes, but they are often blended in practice. Using tax depreciation methods in financial statements creates compliance issues and misaligned reporting. This shortcut can raise red flags during audits and financial reviews.

Inconsistent treatment across similar leases

When similar leases are accounted for differently, it signals a lack of clear policy. Inconsistency makes financial statements harder to rely on and harder to defend. Investors and auditors look closely at this when assessing governance quality.

Poor documentation of management judgement

Lease accounting relies heavily on judgement, especially around lease terms and discount rates. When these decisions aren’t properly documented, the numbers become difficult to support. This significantly increases audit risk and review time.

Why this matters:

These mistakes don’t just affect compliance — they increase audit risk and can quietly undermine confidence with lenders and investors. Clear judgement, consistency, and documentation make a real difference when your numbers are under scrutiny.

Best Practice Approach for Australian Businesses

Getting lease accounting right isn’t just about ticking compliance boxes — it’s about making informed financial decisions that stand up to scrutiny and support long-term business performance.

1. Assess Lease Terms Carefully

Lease terms should reflect management’s genuine intentions, not just what’s written in the contract.
Clearly document how decisions around extension, termination, or renewal options are assessed, including the commercial and operational factors influencing those judgements.

2. Separate Accounting and Tax Treatment

A common mistake is assuming accounting outcomes automatically align with tax treatment.
AASB 16 requirements and ATO lease rules often differ, so businesses must evaluate both separately to avoid incorrect reporting, tax surprises, or compliance risks.

3. Review Regularly

Lease assumptions are not “set and forget.”
Reassess lease terms whenever there are significant business changes such as expansion, downsizing, restructuring, or changes in market conditions to ensure your accounting remains accurate and defensible.

4. Maintain Strong Documentation

Good documentation is your first line of defence during audits and reviews.
Auditors expect to see clear reasoning, consistent application of judgement, and evidence that assumptions are regularly reviewed and approved by management.

5. Seek Strategic Advice

Lease accounting decisions go beyond compliance and reporting.
They directly impact profitability, balance sheet strength, cash flow forecasting, and how stakeholders view the financial health of the business — making expert advice a strategic investment, not a cost.

How Business Avengers Helps Businesses Strengthen Financial Performance

At Business Avengers, we work with organisations across Australia to deliver practical accounting and financial advisory support. Our focus is on helping business leaders achieve clarity, meet accounting requirements, and use financial information to make better decisions.

Correct implementation of AASB 16

We assist with the accurate application of AASB 16 Leases, ensuring lease arrangements are identified and reported correctly. This improves balance sheet accuracy, supports audit readiness, and provides clearer insights for directors and lenders. We have ready to go templates that we can provide to clients.

Determining appropriate depreciation periods

Our team reviews asset registers and assesses useful lives based on how assets are actually used and industry benchmarks. This ensures depreciation reflects economic reality and results in more reliable financial reporting.

Aligning accounting with strategic planning

Accounting should support strategy, not sit separately from it. We align financial reporting and accounting treatments with business objectives, helping leaders use their numbers to plan growth, manage costs, and improve profitability.

Improving financial clarity for directors and lenders

Clear, well-structured financial reports make decision-making easier. We help improve the presentation and interpretation of financial information so stakeholders can quickly understand performance and risks.

Reducing audit and compliance risk

We strengthen accounting processes, documentation, and policies to reduce audit issues and compliance exposure. This proactive approach provides confidence during audits and statutory reporting cycles.

Our approach

Business Avengers goes beyond compliance. We help leaders turn financial information into practical insights that support confident decision-making and long-term sustainability.

Final Thoughts

Understanding why the depreciation period for right‑of‑use assets may differ from owned property, plant and equipment is essential for Australian businesses operating in today’s leasing environment. Getting it right supports compliance, transparency and smarter decision‑making.

If you would like help reviewing your lease accounting or understanding how AASB 16 affects your business, Business Avengers is here to help.