Prevent and Correct Common ASC 842 Audit Adjustments

Navigating the complexities of ASC 842, Leases, presents significant challenges for even the most experienced accounting teams. The shift from off-balance sheet operating leases to on-balance sheet recognition introduced new accounting complexities and necessitates robust processes for compliance. Consequently, ASC 842 audit adjustments: common corrections and prevention have become a critical focus for controllers and accounting managers aiming for clean financial statements. A common challenge observed by auditors is the initial completeness and accuracy of lease data, frequently leading to adjustments during the audit cycle. Ensuring robust controls and diligent preparation can significantly reduce the incidence of these adjustments. Ultimately, the question for many organizations is, "How can my company prepare for an ASC 842 audit?" By understanding common pitfalls and implementing proactive prevention strategies, companies can streamline their ASC 842 audit process and minimize audit findings. ¹

Q: What are common ASC 842 audit adjustments?

A: Common ASC 842 audit adjustments often relate to the completeness of the lease population, accurate lease classification, correct calculation of right-of-use (ROU) assets and lease liabilities, and proper disclosure. These adjustments can stem from overlooked embedded leases, errors in discount rates, or incorrect amortization schedules.

What Auditors Are Actually Looking For

Auditors approach ASC 842 compliance with a focus on several key assertions, primarily completeness, accuracy, valuation, and presentation and disclosure. They are seeking assurance that all transactions and balances related to leases are correctly reflected in the financial statements. The completeness assertion refers to an auditor's objective to verify that all transactions and accounts that should be recorded have been included in the financial statements. This is particularly challenging for leases due to the potential for embedded leases.

Auditors perform lease audit procedures to confirm the accuracy of lease populations and calculations. This includes reviewing lease schedules, verifying discount rates, and assessing management's judgments. Deloitte, for instance, emphasizes the importance of a comprehensive lease inventory and proper classification to mitigate audit risks². They will often start by testing internal controls over lease accounting processes, expecting robust review procedures and segregation of duties.

Q: How do auditors test ASC 842 audit adjustments: common corrections and prevention?

A: Auditors will typically test ASC 842 audit adjustments: common corrections and prevention by reviewing supporting documentation, such as lease agreements and amendment documents. They recalculate ROU assets and lease liabilities, scrutinize discount rates, and reconcile lease data to the general ledger.

Here’s a table summarizing key audit focus areas:

💡 Key Takeaway: The completeness assertion is one of the most scrutinized areas in an ASC 842 audit, requiring organizations to demonstrate a thorough process for identifying all lease contracts and components. Auditors will often apply substantive testing procedures to ensure the accuracy of recorded lease balances.

Key Risks and Failure Points

Several common pitfalls can lead to significant ASC 842 audit adjustments: common corrections and prevention. Understanding these risks is crucial for proactive management.

• Incomplete Lease Population: Many companies fail to identify all contracts containing a lease, particularly those for low-value items or service contracts with embedded leases. The risk here is material misstatement of both the balance sheet and income statement.
• Inaccurate Lease Classification: Misclassifying a finance lease as an operating lease (or vice versa) impacts depreciation, interest expense, and the presentation of cash flows. This can also misrepresent key financial ratios.
• Incorrect Discount Rate Determination: The discount rate (either implicit or incremental borrowing rate) has a significant impact on ROU asset and lease liability calculations. Errors can lead to material valuation adjustments.
• Errors in Lease Modification Accounting: Changes to lease contracts (e.g., extensions, terminations, scope changes) require specific accounting treatment under ASC 842. Incorrect application is a frequent source of adjustments.
• Inadequate Documentation: Lack of clear, thorough documentation supporting lease judgments, calculations, and inputs (like discount rates or lease terms) makes it difficult for auditors to verify balances and can lead to findings.

Right-of-use (ROU) asset is defined as an asset that represents a lessee's right to use an underlying asset for the lease term under ASC 842. Errors in its initial measurement or subsequent amortization are common.

⚠️ Risk Alert: A common audit finding relates to companies overlooking service contracts and supply agreements that may contain embedded leases. Failure to identify these can result in the omission of significant ROU assets and lease liabilities from the balance sheet. This impacts the ROU asset audit significantly. A common failure point is overlooking embedded leases in service contracts.

Calculation Example: Lease Liability Adjustment

Scenario: An entity failed to include a 5-year operating lease with annual payments of $10,000 (paid in arrears) in its initial ASC 842 transition. The incremental borrowing rate is 5%.

Key Takeaway: This calculation demonstrates a material omission that would require an audit adjustment, highlighting the importance of a comprehensive lease identification audit. The omission not only impacts the balance sheet but also subsequent interest expense and amortization.

Practical Checklist for Audit Readiness

Preparing for an ASC 842 audit adjustments: common corrections and prevention audit requires a structured approach. This checklist outlines key activities for accounting teams.

Q: How do I avoid common ASC 842 audit adjustments?

A: To avoid common ASC 842 audit adjustments, implement a robust lease management system, conduct regular reviews of lease contracts for modifications, ensure proper discount rate methodologies, and maintain comprehensive documentation. Proactive internal controls are paramount.

This checklist aligns with our ASC 842 implementation guide.

✅ Best Practice: Organizations with strong execution maintain quarterly lease reviews to proactively identify changes and prevent issues that could lead to ASC 842 audit adjustments: common corrections and prevention controls. Regular review ensures the lease accounting system reflects the most current information.

How Accounting Teams Should Validate Their Approach

Effective validation goes beyond basic data entry; it involves critical review and reconciliation. Accounting teams must establish and document procedures to ensure their ASC 842 balances are auditable. Reference the FASB Accounting Standards Codification on Leases (ASC 842) for specific requirements.

1. Reconciliation to General Ledger: Periodically reconcile the detailed lease schedules (ROU assets, lease liabilities, interest expense, amortization) to the general ledger accounts. Investigate and resolve all discrepancies promptly.
2. Completeness Check of Contracts: Implement a control to systematically review new or renewed contracts for potential leases. This could involve keyword searches in contract databases or a checklist for procurement teams. An embedded lease refers to a lease component contained within a larger contract that may not be explicitly identified as a lease. Training employees on how to identify these can prevent common audit findings.
3. Peer Review of Judgments: Have a senior member of the accounting team or an external consultant review significant lease judgments, such as the lease term (considering options) and the discount rate application.
4. Use of Lease Software Features: Leverage lease accounting software to automate calculations and generate standardized reports, reducing manual error and providing consistent audit trails.
5. Documentation of Assumptions: Every significant assumption (e.g., initial direct costs, residual value guarantees, lease incentives, the incremental borrowing rate) must be clearly documented, including the basis for the assumption and supporting evidence. For additional validation steps, see our lease documentation requirements.

TIP: The AICPA provides guidance on audit documentation, emphasizing that auditors need sufficient appropriate evidence. Accounting teams should think like auditors when preparing their lease documentation to facilitate a smooth audit process.

Common Mistakes and How to Avoid Them

Q: What documentation is required for ASC 842 audit adjustments: common corrections and prevention?

A: Required documentation for ASC 842 audit adjustments: common corrections and prevention includes the original lease agreements, amendments, calculations for ROU assets and lease liabilities, supporting evidence for discount rates, and detailed disclosures. Effective internal controls documentation is also critical. Many organizations struggle with ROU asset measurement without proper documentation.

🚨 Critical: Failure to implement strong ASC 842 audit adjustments: common corrections and prevention controls can lead to significant audit adjustments and even material weaknesses in internal control over financial reporting. This negatively impacts management's assessment of internal controls.

What Strong Execution Looks Like in Practice

For organizations demonstrating strong execution in ASC 842 audit adjustments: common corrections and prevention, the audit process becomes a verification, not a discovery exercise. These companies embed lease accounting into their core financial processes, rather than treating it as a once-a-year task.

One example is a multi-national retail company leveraging a centralized lease management system. This system automatically flags potential new leases from procurement data, calculates lease accounting entries, and tracks modifications in real-time. Before the audit, the accounting team proactively performs a self-review, using a checklist similar to the auditor's, and conducts internal reconciliations. They then provide auditors with a clean, organized PBC (Prepared by Client) list that includes:

• A complete lease population, reconciled to subsidiary ledgers.
• Detailed lease schedules for ROU assets and lease liabilities, with clear inputs.
• Documentation for discount rates, including the basis for the incremental borrowing rate.
• A memo outlining significant judgments and assumptions.

This proactive stance drastically reduces auditor inquiries, shortens fieldwork time, and minimizes the need for material audit adjustments. The result is a cleaner audit report, greater confidence in financial reporting, and improved lease accounting compliance. ³

Next Steps

To further bolster your organization's ASC 842 compliance and minimize future audit adjustments, focus on continuous process improvement and knowledge sharing. Regularly review existing lease accounting policies and procedures, especially after significant business changes or acquisitions. Invest in training for relevant personnel, including those in procurement and legal, to enhance their understanding of embedded leases and the overall impact of lease accounting. Strengthening your internal controls will always pay dividends in audit readiness.

Related Articles

• ASC 842 Audit Readiness Checklist
• Guides to Successfully Complete an ASC 842 Lease Accounting Audit
• Auditing ASC 842 Lease Accounting: An Auditor's Guide
• Preparing for ASC 842 Audits