Theory and Practice
Lessees commonly pay a refundable deposit to the lessor at or before commencement. Typically, such deposits are held by the lessor and returned at lease end if conditions are met (e.g. no damage and all rent paid). They are often interest-free and effectively represent an amount the lessee will get back in the future, meaning there is a financing element.
IFRS
A refundable security deposit is not considered part of lease payments under IFRS 16 (which defines lease payments excluding such collateral amounts). Instead, IFRS requires separate treatment under the financial instruments standards. In practice, the lessee recognizes a financial asset at the deposit’s present value (discounting if material) and records the difference between the cash paid and present value as a prepaid expense or part of the ROU asset cost (IASB, 2016). This approach follows IFRS 9, which mandates that interest-free deposits be measured at amortized cost, recognizing the implicit financing: the lessee effectively lends money to the lessor and will receive it back on lease expiry (IASB, 2014). For example, if a lessee pays a €100,000 deposit for a five-year property lease, and the deposit’s present value is €85,000 (using an appropriate discount rate), the lessee would record a financial asset (deposit receivable) of €85,000 and add €15,000 to the ROU asset (as a kind of prepaid rent). Over the lease, the lessee accretes the deposit asset from €85,000 to €100,000, recognizing interest income of €15,000 (which offsets the “extra” lease expense represented by the higher ROU asset). The lease liability is unaffected by the deposit (it is measured based on rental payments due to the lessor, not including the deposit), and the ROU asset is depreciated including the capitalized deposit difference. Thus, apart from the interest income on the deposit, no net impact hits the Income Statement over the lease term (IASB, 2016; RSM US LLP, 2020).
Practical insight: IFRS treats refundable deposits as a separate financial asset. This ensures the balance sheet reflects the time value of money: the lessor effectively has an additional source of financing from the lessee. The lessee’s incremental borrowing rate (under IFRS 16) or a market rate for a similar instrument is used to compute the deposit’s present value. Often, the effect is small (e.g., short-term deposits or immaterial amounts might not need discounting on materiality grounds), but for significant long-term deposits it can be material. The requirement stems from IFRS 9’s general rule that financial assets and liabilities should be initially recognized at fair value (here, the fair value of an interest-free receivable is less than its nominal value) (IASB, 2014). If the deposit is paid at or just before commencement, IFRS may consider it part of initial direct payments, but the key is whether it’s refundable. A non-refundable upfront fee would typically be treated as part of lease payments (e.g., as additional lease cost or initial direct cost, depending on its nature). Refundable deposits are different because they will be returned, so they are not a cost of obtaining the right-of-use; they are a form of asset (money receivable in the future).
US GAAP
Under ASC 842, refundable deposits are normally excluded from the calculation of the lease liability and handled separately (Financial Accounting Standards Board, 2016b). The lessee records the deposit as an asset (often classified as “Other Assets” or “Deposit”) at the full amount paid, without discounting, and the cash received back at lease end is not part of lease income. There is no impact on the ROU asset’s measurement – the ROU asset reflects only lease payments, not collateral (Financial Accounting Standards Board, 2016b). During the lease, the deposit asset remains on the balance sheet, and when it is refunded it does not affect lease expense (which comprises only the rental payments). In other words, no interest income is recognized on an interest-free deposit under US GAAP, and the deposit does not reduce lease expense; it is simply a receivable, collected at the end of the lease (RSM US LLP, 2020).
Practical insight: The US GAAP approach is simpler (no need to compute a present value or adjust the ROU asset). However, it means that the time value of money element is ignored in the Income Statement. In our example above, the lessee would carry a $100,000 deposit asset throughout and simply remove it when refunded; the $15,000 of “interest benefit” to the lessor over five years would not be explicitly recognized. Economically, the IFRS and US GAAP treatments result in the same total cash flows, but IFRS will report slightly higher lease expenses (due to the larger ROU asset) offset by interest income, while US GAAP will report lower lease expenses (since the ROU asset is smaller) and no interest income. The net income effect over the full lease term is ultimately the same under both standards, but the presentation differs.
UK GAAP
Under FRS 102 (including the post‑2025/2026 revisions), entities are not required to apply IFRS 9, but they may elect to do so as an accounting policy choice. FRS 102 remains a standalone UK GAAP framework, with its own requirements for financial instruments set out primarily in Sections 11 and 12; however, it explicitly permits entities to instead apply the recognition and measurement provisions of IFRS 9 where this is considered more appropriate. This choice reflects a broader principle‑based approach within UK GAAP, allowing entities to balance simplicity against the benefits of alignment with full IFRS, particularly in areas such as classification, measurement, and expected credit loss modelling. Accordingly, while IFRS 9 may be preferable in practice for entities seeking consistency with group reporting or more sophisticated financial risk management, its application under FRS 102 is optional rather than mandatory, and the decision should be based on the entity’s complexity, user needs, and reporting objectives (FRC, 2025; HMRC, 2025b; IFRS Foundation, 2024).
However, under FRS 102, security deposits are accounted for in accordance with the general principles for basic financial instruments and therefore are not automatically measured at face value. Instead, where a deposit represents a financing transaction—such as a long-term, interest-free or below-market deposit—it must be initially recognized at the present value of future cash flows, discounted using a market rate for a similar instrument. This reflects the economic substance of the arrangement, as the deposit effectively provides financing to the counterparty. Subsequently, the deposit is measured at amortized cost using the effective interest method, with the carrying amount increasing over time to the contractual repayment amount. Only where the financing effect is immaterial—typically in the case of short-term deposits—may the transaction price approximate face value. Accordingly, FRS 102 requires entities to consider time value of money and apply discounting where material, ensuring that financial assets such as security deposits are reported on a basis that reflects their underlying economic value rather than simply their nominal amount (FRC, 2018; HMRC, 2025c; Chartered Accountants Ireland, 2024).