The Auditor’s Role in Lease Accounting

When companies collaborate with their auditors it optimizes compliance efforts and minimizes the potential for costly surprises.

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A new survey by LeaseQuery found that 44% of accountants said their auditor had no involvement in their lease accounting transition process leading up to the first post-transition audit.

In this interview, FEI’s Accounting Policy Manager, Josh Mortensen, spoke with LeaseQuery’s Vice President of Accounting, Jennifer Booth, about how COVID-19 has highlighted the need for more advanced technology solutions to lease accounting and how non-public companies can leverage the knowledge the audit firms have gained from public companies.

Josh Mortensen: What were the most significant lessons learned by public companies after transitioning to ASC 842 and IFRS 16 that may be helpful to non-public companies?

Jennifer Booth: As public companies worked to adopt ASC 842, the new lease accounting standard, it became clear that the undertaking was more complex, resource intensive and time consuming than anticipated. To be successful in the integration, companies need to involve individuals from multiple departments in order to ensure a complete inventory of leases. Further, companies need to ensure that they have appropriate individuals with technical accounting experience to ensure they are appropriately identifying policy elections and selecting practical expedients. One of the main lessons that public companies learned was that they needed to start the process – to bite off sections of the business either geographically, departmentally (i.e. IT contracts, supply contracts, etc.) and start reviewing those, rather than working to get an entire population first. If you waited until every lease was identified before analyzing the leases, you may run out of time. It’s best to have a two-pronged approach of identifying the population while also analyzing and accounting for the leases that you have identified.

Many public companies identified that they had a number of embedded operating leases that were previously not recognized. Companies needed to identify and record these lease agreements. Further, companies found the selection of the discount rate was more complex under ASC 842, since the definition has changed and the company can no longer use the Company’s general borrowing rate obtained from the Treasury Department, but instead using a rate specific to borrowing for a similar asset.

The level of effort the transition has required, combined with the impact of these amounts recorded on the financial statements both were larger than originally expected by companies. LeaseQuery’s Lease Liabilities Index study found that the new lease accounting standard led to average balance sheet lease liabilities increases of 1,475%.

Mortensen: How has implementation of the new lease standard helped some companies improve capital management and cash flow?

Booth: Implementation of ASC 842, the new lease standard, forced many public companies to get a better understanding of the nature and population of their lease agreements.  For most organizations, this transition process also helped the centralization of this information. Many public companies implemented a lease software solution. Companies can use the data populated with the software (including information on lease term, purchase options, termination fees, etc.) to help evaluate capital management and cash flow decisions.  Further, some of the best lease software tools include forecasting reporting tools, which can help a company perform the “what if” analyses that can drive cash management decisions.

Especially in this pandemic environment, companies that are utilizing a lease software solution have been better able to pivot their use of a lease software tool from what was originally likely purchased as a compliance tool, to provide value to an organization in terms of cash resource analysis.

Many of the lease software solutions also include a central repository for the lease agreement and any amendments are stored electronically. As many employees have been working remotely, this has been a benefit in that companies that have wanted to renegotiate lease agreements with the lessors had easy access electronically to the documents, rather than having to find them in an on-premise location. 

Mortensen: After adopting the new lease standard, what were the major challenges faced by public companies in their first post-transition audit?

Booth: Many companies tend to believe that once the implementation of the new lease standard is complete, their hard work is over. Far from it. Of the companies LeaseQuery surveyed who completed their first post-transition audit, over 50% reported reasonable to significant additional effort was needed.  Companies should ensure they have appropriately documented the practical expedients and internal policy elections to make it easy for the auditors to evaluate the transition. 

Additionally, given the auditors will be performing more testing on the lease arrangements than they have performed historically, a software tool with read-only auditor access can make this process easier for both parties.

“Day 2” (or the work that comes after implementation) challenges are just beginning and are vastly underestimated. Companies need to ensure that appropriate processes are identified, and internal controls appropriately documented regarding the identification of new leases, changes to lease agreements (which should be accounted for as modifications or terminations). 

Mortensen: What role can auditors play as non-public companies transition to the new lease standard and prepare for the first post-transition audit?

Booth: Auditors are essential when it comes to the lease accounting transition and the post-transition audit. When companies collaborate with their auditors, giving them full access to the organizations’ lease accounting data and software from the beginning of the transition process, it optimizes compliance efforts and minimizes the potential for costly surprises.

Further, auditors went through the compliance process with their public companies. They understood the pain points and also have seen best practices. Non-public companies should reach out to their auditors to learn best practices and get an understanding of the auditors’ expectations, timelines, etc. to reduce the organization’s efforts. This way the company can leverage the knowledge the audit firms have gained from public companies, and the company can speak with their auditors, who have a detailed understanding of their business, to identify and implement best practices that would be applicable for their industry or nature of lease arrangements.    

Mortensen: How has technology improved the transition to the new lease standard and mitigated challenges in the first post-transition audit?

Booth: Technology has improved the transition to the new lease standard as it has enabled companies to more seamlessly gather and analyze leasing info and continue their transition process in a remote environment. Through software, companies can analyze their leases remotely and in real time as their central repository of leases is readily available in the cloud. Companies can also perform “what if” scenarios in order to effectively monitor liquidity needs or determine assets that are no longer deemed necessary in addition to creating accurate account payable reports and enabling the ability to more effectively forecast and budget. Technology has also mitigated challenges in the first post-transition audit by allowing auditors direct access to data and leases without needing to be onsite.  Further, a good lease software solution has read-only role-based access that allows an auditor access to the software.  This is a significant time savings for the company, since they don’t need to pull the client assistance, and for the auditor, since they can access the support for testing real-time...and cost savings corresponds to dollar savings in terms of audit fees and time that employees can allocate to other business initiatives.

Mortensen: How has COVID-19 highlighted the need for more advanced technology solutions to lease accounting?

Booth: Before the pandemic, advanced technology solutions for lease accounting were critical to help companies to meet their compliance needs.   However, many companies had not begun to use the additional value components of a lease software solution, in terms of evaluation of future cash flow decisions.

However, when public companies were transitioning to the lease standard, they had an expectation on the number of new leases or lease modifications that they entered into in the current year.  For some companies, this drove whether or not they relied on a lease software solution.  However, these expectations changed substantially this year, as many companies are renegotiating almost all of their leases, given many buildings or equipment that have been idled due to closures.  All of these changes will need to be accounted for, and if you don’t have a lease software solution, this will be a daunting task to ensure that the changes are processed accurately and the resulting schedules and disclosures are appropriate.

As the pandemic shifts how work is done, where it is done, and what is most important, the need for lease accounting technology solutions is even more crucial as it allows organizations to continue their transition processes and understand their lease portfolio, so they do not fall behind in the complex, time-consuming process and so that they can make the right decisions for their business in a changing market.