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.

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

A robust software solution not only provides a SOC 1 Type 2 report covering the audit period but also an unqualified audit opinion on internal controls. This significantly reduces testing efforts by both the company and auditors, ensuring effective control assurance.

Key Factors for Internal Audit Controls

Implementing ASC 842 compliance requires effective internal controls. Centralized contract management or periodic lease identification surveys are recommended. Two types of controls—preventative and detective—are crucial.

1. Preventative Controls:

Simple controls inserted in the contracting process prevent errors upfront. For instance, adding a question like “Does this agreement contain property or equipment?” acts as a starting point for ASC 842 lease identification.

2. Detective Controls:

Periodic controls involve reviewing contracts and analytical procedures to identify missed leases. An efficient lease accounting solution consolidates detective control reporting, aiding auditors and internal users.

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:

  1. Research what to expect in your first post-transition audit.
  2. Engage auditors early to discuss audit plans and evidence requirements.
  3. Conduct planning meetings focused on lease accounting.
  4. Opt for a specialized lease accounting solution with a reputable SOC 1 report.
  5. Understand that initial audits under ASC 842 might be challenging, but collaboration and preparation will ease the process.

LBMC, largest Tennessee-based CPA firm, has been aiding companies in transitioning to ASC 842 for the past few years. Offering comprehensive lease accounting consulting solutions, LBMC tailors its services to your organization’s needs. Whether you require borrowing rate models, transition white papers, lease data extraction, or full 842 implementation management, LBMC is your trusted advisor.

Read the original article on the LeaseQuery site.