Lease agreements are central to how energy companies operate—whether it’s land for drilling, pipelines, equipment, or office space. But with new accounting standards in full effect, the way these leases are reported has changed dramatically. For players in the energy sector, properly accounting for Right-of-Use (ROU) assets is no longer optional—it’s foundational to regulatory compliance and sound financial reporting.
In This Article:
Why Right-of-Use Accounting Matters in Energy
In the energy sector, leased assets can span vast categories—from drilling rigs to substation properties. Under ASC 842 (U.S. GAAP) and IFRS 16 (international), nearly all leases must now be reflected on the balance sheet as both a Right of Use Asset and a lease liability.
This shift is significant. According to Deloitte, energy and resources companies reported some of the largest lease liability increases under the new standard, with many firms adding billions of dollars to their balance sheets.
Energy firms need to understand not just the rules—but also how to adapt their systems, people, and processes to stay ahead.
What Is a Right-of-Use Asset?
A Right of Use Asset represents your company’s legal right to use an asset during the lease term. It’s recorded on the balance sheet alongside the lease liability, which represents the obligation to make future lease payments.
In energy, this could apply to:
- Leased oil and gas properties
- Compressor stations and pipeline space
- Refinery equipment
- Field vehicles
- Temporary worker housing or trailers
Even embedded leases—such as equipment within a contract that wasn’t labeled as a lease—may need to be recorded.
Key Steps to Account for Right-of-Use Assets
Accounting for ROU assets in the energy industry requires a mix of technical compliance and operational insight. Here’s a practical breakdown of how to get it right:
1. Identify Lease Contracts
Evaluate all agreements for lease components, including service contracts that may have embedded leases. Collaborate with legal, procurement, and operations to capture everything.
2. Classify the Lease
Determine whether each lease is a finance lease (previously known as capital lease) or operating lease under ASC 842.
- Finance leases: Asset and liability are amortized over the lease term, impacting both depreciation and interest expense.
- Operating leases: Straight-line expense, but still recorded on the balance sheet.
3. Measure the Right-of-Use Asset
Calculate based on:
- Lease liability (present value of future lease payments)
- Initial direct costs
- Lease incentives
- Prepaid lease amounts
4. Record and Monitor
Enter the ROU asset and lease liability into your ERP or lease accounting software. Track changes in terms, payment updates, and remeasurements as needed.
5. Disclose in Financial Reports
Ensure your financial statements and footnotes include the required disclosures under ASC 842 or IFRS 16, including the breakdown of lease expenses and maturity analysis.
Challenges Unique to the Energy Sector
Lease accounting in oil, gas, and renewables isn’t just about spreadsheets—it’s about adapting to a highly variable operating model. Some common issues include:
- Variable lease payments tied to commodity prices or usage
- Joint venture agreements with shared lease obligations
- Asset retirement obligations (ARO) embedded within long-term land leases
- Complex land use agreements spanning multiple jurisdictions
Addressing these challenges means aligning finance teams with legal and operational counterparts—and possibly bringing in lease accounting specialists.
Why This Matters for Your Business
If your company is in energy, proper lease accounting is more than compliance—it’s risk management. Poor tracking of lease terms can lead to misstated financials, audit issues, and even loss of investor confidence. By treating ROU asset management as a strategic priority, you’re also strengthening your business for future growth, M&A activity, and financing.
Plus, with ESG reporting on the rise, transparency around lease assets (especially land and infrastructure) is becoming part of the broader sustainability conversation.
Final Thought: Don’t Let Leases Derail Your Strategy
At Rex Energy, financial stewardship is as vital as operational excellence. As lease obligations grow more complex—and more visible—companies that understand and manage their Right-of-Use Assets will gain a real edge.
Compliance is just the baseline. Strategic accounting is what moves your business forward.
