ASC 842 Compliance Audit: A Checklist for Auditors
ASC 842 has significantly changed how businesses handle their accounting lease. All companies reporting under the US Generally Accepted Accounting Principles (GAAP) that fail to comply with these standards face serious reporting issues.
Maintaining ongoing compliance with ASC 842 lease accounting requires constant vigilance and the process can be overwhelming. This blog will serve as your guide, equipping auditors with the tools to assess the effectiveness of internal controls related to ASC 842.
Internal Controls: The Foundation for Accurate ASC 842 Application
ASC 842 prescribes a new business model whereby nearly all leases are recorded on the company’s balance sheet. This model affects the financial ratio analysis and may lead to loan covenant violations. Therefore, strong internal controls are vital in the right implementation of ASC 842. Without a strong foundation, even precise calculations are undermined by flawed data or inconsistent application of the standard.
Risks of ASC 842 Audit and How to Overcome Them?
The organizations are shifting towards ASC 842 and IFRS 16 lease accounting compliance. Auditors are reviewing key areas closely to ensure accuracy and adherence.
Here are five major audit risks and how companies can overcome them.
1. The Lease Data Collection from Departments
The biggest challenge is gathering the lease data for an organization. Leases for equipment are often managed by individual departments which makes visibility difficult. To overcome this, companies should engage all contributors and compile lease data from multiple sources, ensuring nothing is left behind.
2. The Unidentified Embedded Leases
Embedded leases are part of broader agreements (e.g., IT services or security contracts) that are often missed. Auditors must identify these hidden leases, so companies can proactively search for them in contracts to ensure compliance.
3. Taking out the Accurate Data of Lease Components
Extracting the correct lease components is critical, especially in complex agreements. Companies should establish clear policies to distinguish between lease and non-lease components. Organizations must ensure accurate data extraction and documentation.
4. Inaccurate Assumptions and Variables
The crucial assumptions such as exercising options or setting the incremental borrowing rate, impact the value of lease liabilities and assets. The auditors must scrutinize these assumptions, properly document and applied consistently
5. Software and Data Configuration Issues
Robust software is required to record leases on the balance sheet. Many companies are upgrading their lease management systems to handle compliance requirements. Companies must choose proven, reliable software and introduce improvements to mitigate configuration risks.
By focusing on these high-risk areas and adopting a phased approach, companies can ensure compliance and minimize audit risks for ASC 842.
The Role of Auditors for Leases under ASC 842
Auditors have a crucial role in adopting ASC 842, both internally and externally for an organization. Internal auditors help to set up controls and processes for transitioning to the new standard, while external auditors ensure compliance post-adoption. The proper knowledge of how lease audit procedures have changed is essential for a smooth audit process.
Key Audit Assertions for Lease Accounting
Auditors assess six key assertions for lease accounting:
Completeness: Ensures that all leases are captured and properly recorded on the balance sheet. Having evidence ready for this before the audit can help avoid time-consuming procedures and additional audit costs.
Existence/Occurrence:
Verifies whether leases exist. Although not a high-risk area, auditors will confirm that the leases, assets, and liabilities recorded in the financial statements are accurate.
Valuation/Allocation:
Auditors focus on the correct present value calculations of leases, ensuring payment streams, lease terms, and discount rates are accurate and supported by documentation.
Cut-off:
They ensure leases are recorded in the correct accounting period, especially those commencing after the ASC 842 transition date. Auditors will review leases before and after this date to confirm accuracy.
Rights/Obligations:
Verifies that assets are owned (or have the right to be owned) and liabilities are correctly owed. Though risks are generally low, auditors check to ensure there are no discrepancies.
Classification/Presentation & Disclosure:
Ensures proper classification of leases (operating vs. finance) and accurate presentation in financial statements. Auditors may reperform lease classification tests, focusing on the income statement impact.
Improving the Audit Process
To streamline the audit process under ASC 842, you must:
- Conduct thorough research on what to expect in your first post-transition audit.
- Meet with auditors beforehand to discuss their audit plan and ensure all necessary evidence is prepared.
- Implement a lease accounting solution designed for compliance, ideally one with a reputable SOC 1 report, to simplify evidence gathering and reporting.
- By being proactive, companies can minimize audit risks and ensure a smoother experience in future audits.
Assistance of Finance consulting for Seamless ASC 842 Compliance
Navigating the complexities of ASC 842 compliance can be daunting. Getting assistance from a financial consultant can ensure your company is compliant with ASC 842 while streamlining your lease accounting process.
Here is how a financial consultant can help you
Experienced Lease Accounting Professionals:
Thorough research is necessary before hiring a consultant. He must hold Certified Public Accountants (CPAs) and Certified Leasing Professionals (CLPs) with proven expertise in ASC 842 implementation and compliance.
Technology-Driven Solutions:
The consultant must have knowledge of advanced technology platforms to streamline lease data management, automate calculations, and generate compliant lease accounting disclosures.
Scalable Services:
Their services must deliver your organization’s specific needs, whether you’re a small business or a large multinational corporation.
Collaborative Approach:
The consultant must work closely with your finance team to ensure a smooth implementation process, with responsive ongoing support throughout your ASC 842 journey.
Conclusion:
Compliance with ASC 842 is an ongoing process. Internal controls are not static and require constant monitoring and adaptation. As companies enter into new leases or modify existing ones, the effectiveness of the internal controls needs to be reevaluated.