By Stephen G. Austin, CPA; Joel Colbourn; Phillip Doolittle; and Doug Renner
March 1, 2020
New processes and controls will be evaluated by internal and external auditors.
Public companies' required implementation of FASB's new lease accounting standard in 2019 means that financial statement auditors need to be prepared to make new judgments.
Although the private company implementation date for the standard hasn't yet arrived, auditors of both public companies and private companies that prepare financial statements in accordance with GAAP will eventually need to determine whether adequate work has been performed to ensure a reasonable opening entry upon implementation. As part of understanding the entity's processes and controls, auditors also will have to assess whether their clients or companies (in the case of internal auditors) have adequate go-forward processes in place to ensure that upon execution of a contract, a determination is made as to whether that contract is, or contains, a lease.
The new standard (FASB ASC Topic 842, Leases) calls for recognition of lease liabilities and right-of-use assets for lease arrangements previously identified as operating leases and capital leases (which are now called finance leases). This means that on the first day of a new fiscal year, the entity will have to prepare accounting entries to record this recognition. The auditor needs to understand how the client determined the entry balances recorded through this opening entry.
Most companies will adopt the package of three practical expedients by which the leases identified and recorded in the prior year will carry forward as the foundation for the opening entry. This assumes the previous accounting was handled correctly — perhaps a precarious assumption. The new accounting standard does not grandfather in accounting errors. Rather, they need to have been corrected under the old guidance before moving forward.
There are a couple of other key policy decisions with potentially significant consequences. First, there is the accounting policy election to not apply the lease liability and right-of-use asset recognition requirements to leases with initial terms of 12 months or less.
The second key accounting policy election is whether to separate lease and nonlease components, which is done by designating applicability of the election to specific asset types. For many asset types this election can eliminate what might otherwise be an administrative nightmare. For example, it may not be meaningful to financial statement readers if the service component of a copier lease was separated as a nonlease component and excluded from the calculation of the lease liability and right-of-use asset. On the other hand, a large security guard service contract that includes a low-dollar-value golf cart could result in a larger-than-expected lease liability and right-of-use asset balance if this election was applied. Materiality might indicate that it is not appropriate to apply this policy election to asset types where it just does not make sense.
While leasing arrangements generally address a continuing business need, business seldom actually happens as envisioned. The entity needs to be aware of the developments because the entity is responsible for the reassessment, remeasurement, or impairment adjustments. The auditor needs to understand the entity's process for identifying developments, and the auditor needs to obtain evidence about the adjustments.