What Audit Firms in Dubai Should Know About The Updated Audit Procedures Under ASC 842?
We’re counting down to ASC 842 compliance. As of 2019, companies will have to report most operating leases on their balance sheets thanks to the new lease accounting standard from the Financial Accounting Standards Board.
Essentially, ASC 842 is all about improving transparency, comparability, and financial reporting, but getting to compliance is tough. To ensure that their organization is ASC 842 compliant, tax and accounting teams will now be required to implement new tasks and workflows.
To avoid material misstatements, material weaknesses, or malpractice suits, having a solid plan and effective tools is crucial.
Read also: ASC 842 Disclosure Requirements: How Dubai Accounting Services Can Avoid Pitfalls
For lease accounting, there are six audit assertions
Auditors have been performing assertion-level audits for a long time. Knowing how your auditors assess risk and mitigate that risk is important for understanding what to expect in an external audit.
1. Completeness
Completeness, a major audit criterion involving leases, portrays a balance sheet that accounts for all leases. Lessors are required to recognize rights-of-use assets and lease liabilities for operating leases under ASC 842.
Therefore, both serving and finance leases will be remembered as assets and liabilities. Having completeness evidence prepared before your auditor walks in the door is the easiest way to ensure the auditor doesn’t spend too much time on this assertion.
2. Existence/Occurrence
Lease Existence/Occurrence asserts whether the lease does or does not exist. Auditors generally do not spend much time on this assertion since financial statement preparers may have incentives to underestimate liabilities such as lease liabilities.
Depending on how management evaluates a company’s financial results, the company might be incentivized to overstate assets without considering lease liabilities. Therefore, the auditor would ensure that physical assets and contracts exist were executed.
3. Valuation/Allocation
Value/Allocation ensures that your leases are valued appropriately. This calculation is primarily based on payment streams, lease terms, and discount rates. Auditors will ensure these components are in line with the contract or are supported by evidence.
It would also benefit the company to understand how the software provider determines calculation and report accuracy. This can be helped a great deal with an Agreed-Upon Procedures (AUP) report from a reputable firm. The AUP report can reduce the testing required by your company and auditors, and your calculations will be more secure.
4. Cut-off
Cutting-off establishes whether the lease belongs in the right accounting period. A lessee with a lease beginning after the ASC 842 transition date should recognize the lease on the lease commencement (or possession) date after the transition date. Auditing leases will test this before and after your transition or reporting date.
The cut-off procedures would apply to leases after the transition date in the practical expedients package since the lease term and classification would not change. Companies can re-evaluate lease terms when transitioning using a hindsight practical expedient. Auditors will have to perform cut-off procedures before and after transition if a company uses the hindsight practical expedient.
5. Rights/Obligations
A right is something owned (or owned), and a liability is something owed. Leases result in assets and liabilities that are approximately equal, so the risks are somewhat neutralized. In Existence/Occurrence, it was mentioned that a firm’s financial incentives might align to make this claim risky.
6. Classification/Presentation & Disclosure
The financial statements have been appropriately classified, according to Classification/Presentation & Disclosure. Operating leases generally fall into one of two categories: finance leases or short-term leases – for which the lease liability and corresponding right of use are not recorded on the balance sheet or otherwise. Considering the impact on income statements of misclassification such as EBITDA. This is a significant area of audit scrutiny.
ASC 842 classification testing may be performed on a sample of leases by an auditor. Some software solutions, such as LeaseQuery, keep this information with the PDF contracts for easy auditing.
Upon transition to ASC 842, many customers use the package of practical expedients. Therefore, during the transition, the lease classification would not change for a company’s lease agreements (and therefore would not be subject to re-testing).
How to Evaluate Lease Accounting Software
Easing internal control testing
Customers will benefit from a version of the software that includes a clean or unqualified audit opinion on internal control over financial reporting, in addition to the SOC 1 Type 2 report covering the period under audit. During the period covered by the SOC 1 reports, the company can ensure that logical access and program change procedures are effective. SOC 1 assures control while reducing testing for the company’s auditors.
Controls for internal audit
Documented internal controls can significantly impact a company’s efforts to meet ASC 842 compliance. Businesses should have a contracting process to identify assets (and potential lease agreements) in their deals. Contract approvals are recorded in this process, which is a centralized contract management tool. Contracting is decentralized, and key team members are periodically surveyed to identify leases in a less than ideal but workable situation.
Read also: How Audit Firms in Dubai Can Identify An Embedded Lease Within a Contract
