Lease Audit Procedures: Accounting Best Practices

Last Updated on March 6, 2024 by Morgan Beard

Lease audit procedures refer to the process of reviewing and examining an organization’s lease agreements and related records to ensure compliance with the applicable accounting standards, contractual obligations, and internal policies. These procedures are typically performed by internal or external auditors and are essential for maintaining accurate financial reporting and effective lease management.

In this blog post, we will provide a comprehensive guide to implementing effective lease audit procedures that align with best practices. We will cover key areas that auditors focus on, steps to streamline the audit process, and tips to make your first lease audit under the new standards less stressful.

Lease Accounting Assertion Focus Areas

When planning audit procedures, external auditors focus on assessing certain assertions related to lease accounting and reporting. Every portfolio has unique lease language. It’s best to house detailed records of your leases in a lease administration software in order to easily access your rights & obligations, base rent, lease payments, CAM charges and lease amortization schedules in advance of your lease audit. In this section below, we will identify the lease audit procedures and the key assertions auditors will evaluate in order to ascertain with reasonable assurance that the financial statements are accurately portraying leasing data obligations:

Completeness Assertion

The completeness assertion is an essential concept in lease accounting under ASC 842. It ensures that all leases, lease-related transactions, and relevant data have been accurately identified, recorded, and reported in the financial statements. Read an in-depth article about the completeness assertion within lease accounting guidelines.

Existence / Occurrence

The existence / occurrence asserts that leased assets and contracts exist and leasing transactions have occurred. Auditors will select samples of leases to verify that the physical assets actually exist and that the lease contracts are valid legal agreements that the company has entered into. Testing procedures may include site visits to inspect assets and reviewing contract documentation to ensure occurrence of transactions.

Valuation/Allocation

Valuation asserts that leases have been valued properly, with accurate present value calculations. Auditors will check that the key inputs used to calculate present value, such as payment streams, lease terms, and discount rates, are supported by the lease contracts and amendments. They will recalculate present value calculations to verify appropriate valuation and allocation methodology was followed in accordance with accounting standards.

Cut Off Assertion

Cut off assertion stipulates that leases are recorded in the proper accounting period. Auditors will select leases from periods before and after the transition date to ASC 842 or IFRS 16 to verify recording in the proper accounting period. Testing procedures will include checking lease commencement and transition dates to ensure leases are captured in the correct reporting period.

Rights and Obligations Assertion

The rights and obligations assertion outlines that the company has the right to use leased assets and obligation to make payments. Auditors will review lease contracts to ensure they properly convey the rights to use the identified asset and the obligation to fulfill payment terms. They will also check for proper accounting treatment of incentives and ensure they are recorded as reductions to the lease liability.

Lease Classification

This tests that leases are classified appropriately as operating or finance. Misclassification affects financial ratios like EBITDA. Auditors will select a sample of leases to perform the companies’ classification testing to ensure operating and finance leases have been properly differentiated. They will check classifications against criteria like lease term and present value thresholds.

Presentation / Disclosures

Auditors will inspect lease information in financial statements to ensure it complies with accounting standards. Auditors will thoroughly check financial statement disclosures around leasing to ensure proper presentation and disclosure of lease details, terms, expenses, cash flows, and other information as required by accounting standards like ASC 842 and IFRS 16. They will verify disclosure completeness and accuracy.

Streamlining the Audit Process

To make the lease audit more efficient for both your internal team and external auditors, here are some best practices:

Centralize lease data and documents in an accounting software system. This enables easy auditor access.
Perform rent expense reconciliations and document your lease inventory process before auditors arrive.
Discuss audit plans with auditors upfront to understand focus areas and have evidence ready.
Utilize preventative controls like lease questions on contracting forms to identify leases early.
Implement detective controls like periodic reviews of lease accounting conclusions and analytical checks.
Evaluate SaaS accounting tools that offer SOC 1 audit controls to reduce testing.
Set up compliance controls like lease classification checklists in your system workflow.

Internal Audit Control Frameworks

Implementing robust internal controls is critical for lease accounting compliance under new standards like ASC 842 and IFRS 16. Organizations should develop comprehensive control frameworks that address key risk areas and processes. Though structures may vary, effective lease accounting internal audit programs typically include four core components:

1. Preventative Contracting Controls

Preventative controls are proactive measures implemented early in processes to avoid errors. For leases, key preventative controls occur during the contracting stage. Example controls include:

Requiring lease screening questions on all contracting request forms to identify potential leases upfront.
Mandating legal/finance review of contracts to evaluate lease accounting implications before signing.
Utilizing e-signatures with built-in lease classification questionnaires to prevent missed identification.
Embedding lease classification logic in contracting software workflows to automate identification.

2. Detective Data Analysis Controls

Detective controls involve performing analytics and reviews to identify issues after processes occur. Lease accounting detective controls include:

Reconciling lease asset listings to the general ledger and financial statements to catch discrepancies
Analyzing rent and lease expense data to find outliers that may indicate missed leases.
Selecting lease samples periodically to review classification, modification, and disclosure compliance.
Comparing lease terms to equipment useful lives and assessing reasonableness.

3. Monitoring Policy Compliance

Ongoing monitoring ensures lease accounting policies and procedures are followed consistently. Examples include:

Tracking required lessor and lease data that is collected and retained.
Reviewing lease classification, modification, impairment, and termination processes for conformity to accounting policies.
Verifying new process workflows, access controls, and system integrations function as intended after changes.
Assessing trainings and communications to ensure accounting policies are understood.

4. IT System Access Controls

Robust IT controls and SOC 1 reports for software providers are necessary to ensure data integrity for lease accounting:

Restricting lease accounting system access and segregating duties between teams.
Implementing strong password requirements and timely deactivation procedures.
Maintaining comprehensive backups and disaster recovery systems.
Carrying out routine audits of user access logs for high risk system transactions.
Validating system interfaces, data transfers, and underlying lease calculations.

Developing a matrix of preventative, detective, compliance, and IT controls provides a layered risk-based audit approach to lease accounting.

Lease Audit Preparation

With major changes to lease accounting standards in recent years, it is more important than ever for organizations to have robust audit procedures in place. Lease audits require additional diligence to ensure compliance and accurate financial reporting under new standards like ASC 842 and IFRS 16. In order to set up their finance teams for audit success, companies need to understand what is required and how to best prepare.

This section will provide a comprehensive guide to implementing effective lease audit procedures aligned with current best practices. We will cover key focus areas for auditors assessing lease accounting assertions, steps organizations can take to streamline the audit process, and tips to make your first lease audit under ASC 842 or IFRS 16 less stressful. Implementing the procedures outlined in this guide will help minimize compliance risk and give both internal and external auditors the necessary tools to verify the validity of lease accounting and reporting. With the proper preparation, organizations can have increased confidence that their financial statements accurately reflect lease transactions.

Lease Accounting Audit Checklist

To help commercial tenants prepare for their lease accounting audit efficiently under the new standards, we’ve created a comprehensive Lease Accounting Audit Checklist. This checklist contains the key audit procedures, internal controls, and required accounting entries documentation needed to audit your lease transactions, journal entries, and financial data at your year-end.

Using a solid lease accounting audit checklist is essential for effectively auditing leases under the new standards. Our checklist summarizes the key procedures and financial records auditors need. Download our free checklist to improve your lease accounting audits.

Tactical Steps to Creating Internal Audit Procedures

Your lease accounting audit after adopting the new lease standards requires additional preparation:

Research common audit challenges and expectations under the new standards
Proactively communicate with auditors before fieldwork begins.
Schedule a planning meeting focused on lease accounting.
Walk through your new lease accounting policies and transition adjustments.
Provide an inventory of all leases with major terms and conclusions.
Construct lease testing samples for auditors based on their criteria.
Have reports and lease documents ready in your centralized system.
Anticipate additional audit fees and testing for this first-time process.