Top 5 Audit Risks for Lease Accounting Compliance and How to Expertly Overcome Them
For years, corporate accounting teams have been implementing policies and processes for ASC 842 and...
With less than six months away to comply with ASC 842, there is a warning to be shared with private companies. These companies need to prepare now and understand the pitfalls that can hinder them throughout the life of their compliance journey. The deadline to implement ASC 842 for private calendar year-end companies is January 1, 2022. Non-calendar companies follow at the start of their respective fiscal years.
Beginning the Compliance Process
Implementing the new leasing standard takes a lot of time and resources, so it’s best to start many months in advance. Some companies may have procurement departments that handle and store all leases, while others obtain and store documents within various departments. Operating leases for real estate, vehicles, IT equipment, heavy machinery, and manufacturing equipment now must be accounted for on the balance sheet. Companies may not even be aware that inside their service contracts, such as one for IT services, a lease is embedded for the use of routers or fiber optic cables.
It takes time for companies to find all their leases and the documents associated with them, especially when they are housed within different departments. Many departments have been accustomed to leasing assets with very little impact on or involvement from other internal groups. Because old accounting rules did not require operating leases to be capitalized, a large portion of leases were approved based on expense budgets in a decentralized process, and records were simply kept by each department.
For this project and in the future, all company leases should be stored in one location as anytime they may need to be reviewed by accountants or auditors.
Since ASC 842 compliance requires detailed expertise and input from different departments, private companies should elect someone with knowledge of ASC 842 to lead the project and work with other stakeholders, such as the real estate, business, financial, IT, legal, and procurement teams, to ensure they all understand their part in compliance. ASC 842 knowledge can be gained by reading documents on the websites of the Financial Accounting Standards Board (FASB) and the Big Four accounting firms, as well as by taking eLearning classes that simplify ASC 842 so that it’s easily understandable.
What’s Next?
Once all hard and digital lease documents have been gathered, they should be compared to lease data in spreadsheets to ensure no data is missing and all entries are accurate, including the classification of a lease. What used to be called a capital lease under ASC 840 is now called a finance lease under 842. Companies have been known to misclassify their leases under 840 and re-misclassify them again under 842. Companies may elect a practical expedient to avoid reassessing lease classification upon adoption of ASC 842, but that expedient is not intended to grandfather in errors. An accounting test is used to determine whether a lease is an operating or a finance lease. Based on ASC 842 policies, mature lease accounting software determines when a lease may have been wrongly classified and will send a user an immediate warning to double-check.
Unless they only have a handful of leases, private companies will need lease accounting software as it’s too time-consuming to perform in spreadsheets all the calculations needed to comply with ASC 842. For example, creating an initial amortization schedule can take up to an hour, and each time it’s revised it can take just as long. Most lease accounting software can create initial amortization schedules in seconds, but only the most powerful lease accounting software can automatically revise schedules.
As well as getting educated on the technicalities of ASC 842, it’s important to learn about the differences among lease accounting software solutions. It’s deceiving to watch online product demonstrations. It’s not until a company begins using the software and following the processes to comply with ASC 842 that accountants can readily determine the numerous flaws in a product that forces them to conduct manual workarounds that take an hour in spreadsheets.
The best way to begin learning about these flaws before getting stuck with a product that won’t handle many ASC 842 processes is by reading about them here (link to Accounting Today blog) and then talking with a few different providers to thoroughly discuss these common issues. Verify that information a provider claims to be true really is. For example, lease accountants could ask to see samples of a vendor’s standard financial reports, such as the roll-forward and disclosure, so they can be sure the supporting details are clearly in the report.
Although the initial processes of reaching compliance may seem daunting, the quicker private companies begin gathering their lease documents, educating themselves on ASC 842 requirements, and understanding the flaws and benefits of lease accounting software, the easier the road to reaching and maintaining compliance.
