This guide has been developed in collaboration with LeaseQuery, a trusted partner of LBMC.
During the adoption of ASC 842, auditors, whether internal or external, play pivotal roles. Internal audit expertise aids in establishing controls and processes for transitioning to the new standard and post-compliance reporting. Sharing transition plans with external auditors is crucial to avoid surprises in the first audit after ASC 842 adoption. Let’s explore the changing landscape of lease audit procedures under ASC 842 and provide insights into what you can expect.
For organizations managing complex lease portfolios or working to strengthen ongoing ASC 842 compliance, specialized lease accounting services can help address lease data, accounting calculations, documentation, internal controls, and audit readiness.
Understanding the Six Audit Assertions for Lease Accounting
Auditors have long evaluated risk and conducted audit procedures at the assertion level. To prepare for your external audit, it’s essential to grasp how auditors assess risk and employ procedures to mitigate these risks. In today’s digital age, auditors heavily rely on clients’ systems for audit evidence. For leases, auditors seek detailed descriptions of their clients’ leasing systems and processes. This insight informs their audit procedures. Here, we’ll outline the audit procedures our firm utilizes to assess risk.
1. Completeness
Completeness, a critical audit area for leases, ensures that all leases are properly captured and capitalized on the balance sheet. With ASC 842, lessees must recognize a right-of-use asset and a lease liability for operating leases. To streamline this assertion, prepare completeness evidence before your auditors arrive. Reconciling rent expense to lease agreements and cross-referencing with lease accounting software or spreadsheets is a best practice. Additionally, validate procedures used to evaluate all leases, including embedded leases and equipment leases.
2. Existence/Occurrence
Existence/Occurrence assesses the actual existence of leases. While this isn’t a high-risk area for leases, auditors confirm the presence of physical assets and contracts to ensure accuracy.
3. Valuation/Allocation
Valuation/Allocation ensures accurate present value calculations of leases. This involves verifying payment streams, lease terms, and discount rates against contract terms.
4. Cut-off
Cut-off ensures proper lease recording within the correct accounting period. Auditors review leases before and after the transition date to guarantee accurate recognition.
5. Rights/Obligations
Rights/Obligations ensures that assets are owned, and liabilities are owed. While lease-related risks often balance out, auditors consider potential misalignments between incentives and assertions.
6. Classification/Presentation & Disclosure
Classification/Presentation & Disclosure guarantees accurate classification in financial statements. Auditors verify proper classification of leases, avoiding misclassification of operating leases as finance leases or short-term leases.
Elevating Internal Control Testing
Effective lease accounting controls can make the audit process more efficient by improving the reliability, consistency, and traceability of lease data. Organizations should maintain documented processes for identifying new or modified leases, reviewing key assumptions, approving changes to lease records, and reconciling lease accounting information to the general ledger.
When organizations use third-party lease accounting software, auditors may also evaluate relevant SOC reports and the controls the organization has implemented over its use of the system. Strong controls over both the technology and the underlying lease accounting process can reduce the risk of incomplete or inaccurate financial reporting.
Key Factors for Internal Audit Controls
Ongoing ASC 842 compliance requires controls that help ensure leases are identified, recorded, updated, and reported accurately. Centralized contract management, defined responsibilities, periodic lease identification procedures, and documented review processes can help reduce the risk that lease activity is missed or incorrectly accounted for.
Two important categories of controls are preventative and detective controls.
1. Preventative Controls
Preventative controls are designed to reduce errors before they enter the lease accounting process. For example, organizations can incorporate questions into procurement or contracting workflows that identify whether an agreement contains the use of property or equipment. This creates an early checkpoint for determining whether an arrangement may contain a lease that requires further evaluation under ASC 842.
2. Detective Controls
Detective controls help identify leases, modifications, or accounting errors that may have been missed. These can include periodic contract reviews, reconciliations, analytical procedures, and comparisons of lease-related expenses to the organization’s lease population. Lease accounting technology can support these controls by centralizing data and providing reporting that allows accounting teams and auditors to identify exceptions more efficiently.
Enhancing the Audit Process for Lease Accounts
ASC 842 presents learning curves for businesses and auditors alike. A proactive approach can ensure a successful post-transition audit:
- Research what to expect in your first post-transition audit.
- Engage auditors early to discuss audit plans and evidence requirements.
- Conduct planning meetings focused on lease accounting.
- Opt for a specialized lease accounting solution with a reputable SOC 1 report.
- Understand that initial audits under ASC 842 might be challenging, but collaboration and preparation will ease the process.
Supporting Ongoing ASC 842 Compliance
ASC 842 compliance does not end with implementation. Organizations must continue identifying new leases, evaluating modifications, maintaining accurate lease data, documenting accounting conclusions, and supporting balances and disclosures during the audit process.
LBMC’s lease accounting services help organizations manage these ongoing requirements. Depending on your needs, our team can assist with lease data extraction, accounting calculations, technical documentation, discount rate considerations, process improvements, and other aspects of ASC 842 compliance and audit readiness.
Organizations with broader financial reporting, audit readiness, or assurance needs can also explore LBMC’s audit and assurance services. Our professionals work with organizations to address complex accounting requirements, strengthen financial reporting processes, and prepare for an efficient audit.
Read the original article on the LeaseQuery site.
