We get it. Sometimes, the alphabet soup of leasing-adjacent terms is enough to make your eyes water and brain melt.

That’s nothing, however, compared, to the physiological reactions you’d have if your accounting team screwed up something very important to your company’s bottom line. Some things are – dare we say – critical to get right.

What are critical audit matters? 

If an auditor finds something material during their audit of a company's financial statements that is especially challenging, subjective, or complex, the auditor is required to report that matter to the company's board of directors (the audit committee).  

That is called a Critical Audit Matter or a CAM.

The consideration of these began in earnest in 2020. A Deloitte analysis from that year of public filings showed that there was an average of 1.8 critical audit matters in the auditor’s reports for large accelerated filers with fiscal years ending on or after June 30, 2019. The most commonly disclosed critical audit matters related to:

• Goodwill and intangible assets (35%)
• Revenue (19%)
• Income taxes (15%)

Samatha Ross, former special counsel at the Securities and Exchange Commission (SEC), states: “Critical audit matters are a valuable communication tool, especially in times of disruption and uncertainty. A good audit report should be the starting point for investors looking to understand the areas of the audit that required the most judgment and what the auditor did to ascertain whether the financial statements as a whole are free of material misstatement.”

Even more importantly, auditors are documenting CAMs related to lease accounting!

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Types of critical audit matters

The primary areas of concern have been asset impairment, fair market value, and incremental borrowing rate:

Impairment - Companies are required to test asset groups for impairment, and lease ROU assets are no exception. One nuance of ASC 842 is that the pattern of depreciation of an operating lease ROU asset changes after an impairment.

Fair market value (FMV) – The FMV is a key variable required for finance vs. operating lease testing, it is also relevant for impairment calculations, when determining favorable or unfavorable terms during business combinations, and in other lease accounting business cases.

Incremental borrowing rate (IBR) – the IBR is the interest rate a lessee would have to pay to borrow funds to finance an asset similar to a lease’s right-of-use (ROU) asset—over a similar term and in a similar economic climate.

This makes it critical to have lease accounting solutions that offer automation for impairment remeasurement events, fair market value determination and support with industry-standard market research data, and IBR matching technology to make sure the correct rate is chosen every time.