ASC 842 Compliance Audit: A Checklist for Auditors
The implementation of ASC 842 significantly impacted lease accounting. Companies grappled with adapting to the new standard, ensuring accurate financial reporting, and navigating its complexities. Maintaining ongoing compliance with ASC 842 requires constant vigilance. This blog serves as a 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 mandates a new lease accounting model that requires the recognition of most leases on the balance sheet. This model impacts financial ratios and potentially triggers loan covenant breaches. Robust internal controls are essential for accurately applying ASC 842. Without a strong foundation, even meticulous calculations are undermined by flawed data or inconsistent application of the standard.
Here are several critical internal control areas that illuminate the path towards ASC 842 compliance:
- Lease Identification and Classification: A critical aspect is identifying all arrangements that qualify as leases under ASC 842. The definition hinges on the transfer of control of the underlying asset and the presence of economic benefits from its use. Auditors will scrutinize lease identification procedures, supporting documentation, and the company’s application of the “transfer of control” and “economic benefits” criteria to various agreements. This includes sale and leaseback transactions, operating leases with bargain purchase options, and vendor financing arrangements that may be disguised as leases.
- Lease Data Accuracy and Completeness: Clean and accurate lease data is essential for ASC 842 calculations. Inaccurate data can lead to misstated lease liabilities, right-of-use assets, and lease expenses. Auditors will assess controls over lease data capture and processing, focusing on areas like lease inception procedures, data entry accuracy, and integration with other systems. Substantive testing on crucial data points, such as lease terms, lease payments, and guaranteed residuals, will be performed to ensure data completeness and reliability.
- Lease Accounting Calculations: Selecting the appropriate discount rate is crucial for accurate lease accounting. The discount rate reflects the time value of money and impacts the present value of lease payments, a vital component of the lease liability calculation. Auditors will review the discount rate selection process, ensuring it aligns with the company’s incremental borrowing rate or a well-supported benchmark rate. They will also test the accuracy of lease term determination, particularly for leases with renewal options or contingent rentals, and scrutinize the calculations of lease payments, including the present value of lease payments and right-of-use asset amortization.
- Lease Accounting Disclosures: The final step involves ensuring the company faithfully translates its lease accounting into clear and concise disclosures under ASC 842. These disclosures should be transparent and user-friendly to facilitate informed decision-making by financial statement users. Auditors will meticulously compare lease disclosures with accounting records and underlying lease agreements. This review guarantees that the disclosures are complete and accurately portray the company’s lease obligations, including lease payment obligations, lease terms, and contingent rentals.
Audit Procedures: Assessing Control Effectiveness
A series of well-defined audit procedures can evaluate the effectiveness of these internal controls. These procedures are your tools, allowing you to meticulously examine the company’s internal control framework related to ASC 842. Let’s delve deeper into specific audit procedures for each control area:
1. Lease Identification and Classification
- Review documented lease identification procedures and supporting flowcharts. These documents should outline the process for identifying potential leases and applying the ASC 842 definition.
- Select a sample of contracts and assess their classification as leases or non-lease components based on ASC 842 criteria. This involves analyzing factors like transfer of control, lease term, and payment obligations.
- Interview personnel responsible for lease identification to understand their application of the standard. Gaining insights into their thought processes can highlight potential areas of weakness.
2. Lease Data Accuracy and Completeness
- Evaluate the controls over lease data capture, including lease initiation procedures and data entry processes. Please ensure that lease data capture procedures are optimized to minimize errors.
- Perform substantive tests on key lease data points, such as lease terms, lease payments, and guaranteed residuals. This might involve recalculations and comparisons to source documents.
- Assess the completeness of the lease inventory by comparing it to relevant contract databases and operational departments. Ensure all lease arrangements are identified and included in the accounting records.
3. Lease Accounting Calculations
- Review the company’s process for selecting the discount rate, including determining the incremental borrowing rate or choosing a benchmark rate. This involves understanding their methodology and ensuring it aligns with ASC 842 guidance.
- Test the accuracy of the discount rate used by recalculating it with alternative methodologies and comparing the results. This helps identify potential errors in the discount rate selection process.
- Scrutinize the lease term determination process, particularly for leases with renewal options or contingent rentals. Ensure these options are factored in correctly when calculating the lease term for ASC 842 purposes.
- Test the calculations of lease payments, including the present value of lease payments and right-of-use asset amortization. To identify discrepancies, perform recalculations and compare them to the company’s calculations.
4. Lease Accounting Disclosures
- Compare lease disclosures in the financial statements with the supporting lease accounting records and underlying lease agreements. Ensure the disclosures accurately reflect the information in the underlying documentation.
- Evaluate the completeness of lease disclosures, ensuring they cover all required elements such as lease payment obligations, lease terms, and contingent rentals. Auditors should include material lease information from the disclosures.
- Assess the clarity and conciseness of the lease disclosures, ensuring they are readily understandable by users of the financial statements. The auditors should minimize technical jargon, and the disclosures should be presented in a clear and informative manner.
Partnering with HubDigit for Seamless ASC 842 Compliance
Navigating the complexities of ASC 842 compliance can be daunting. By partnering with HubDigit, you can gain the peace of mind that comes with knowing your organization is on the right track towards ASC 842 compliance. Here’s what sets HubDigit apart:
- Experienced Lease Accounting Professionals: Our team comprises Certified Public Accountants (CPAs) and Certified Leasing Professionals (CLPs) with proven expertise in ASC 842 implementation and ongoing compliance.
- Technology-Driven Solutions: We leverage advanced technology platforms to streamline lease data management, automate calculations, and generate compliant lease accounting disclosures.
- Scalable Services: Our services are adaptable to your organization’s specific needs, whether you’re a small business or a large multinational corporation.
- Collaborative Approach: We work closely with your finance team to ensure a smooth implementation process, with responsive ongoing support throughout your ASC 842 journey.
Contact HubDigit today for a free consultation to discuss your ASC 842 compliance needs and explore how HubDigit can empower your organization to achieve financial clarity and peace of mind.
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, modify existing ones, or update their accounting policies, the effectiveness of the internal controls needs to be reevaluated.