Understanding ASC 842 close process: complete monthly checklist
The monthly close process for lease accounting under ASC 842 presents significant challenges and audit risks for organizations. Navigating the complexities of this standard requires a robust, repeatable process to ensure financial statements accurately reflect lease obligations and rights-of-use assets. This ASC 842 close process: complete monthly checklist provides controllers, accounting managers, and auditors with practical guidance to achieve efficient and compliant lease accounting month-end procedures. Adhering to this structured approach is critical, as ASC 842 close process: complete monthly checklist is defined as the assurance that all contracts meeting ASC 842's definition of a lease have been identified, evaluated, and recorded in the organization's financial statements. A well-executed monthly checklist minimizes errors, reduces audit findings, and strengthens financial reporting integrity.
What is ASC 842 Close Process: Complete Monthly Checklist Under ASC 842?
Q: What is the monthly closing checklist for ASC 842 lease accounting? A: The monthly closing checklist for ASC 842 lease accounting is a systematic series of steps designed to ensure the accurate and complete recognition, measurement, and disclosure of lease transactions in a company's financial statements at the end of each reporting period. It encompasses activities from identifying new leases to performing reconciliations and preparing journal entries.
What Auditors Are Actually Looking For
Auditors approach the ASC 842 close process with a focus on completeness, accuracy, and appropriate presentation and disclosure. Their primary objective is to obtain sufficient appropriate audit evidence regarding management’s assertions related to lease accounting. Specifically, they scrutinize internal controls (especially regarding the completeness assertion), the lease population, and the calculations for right-of-use (ROU) assets and lease liabilities. 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 paramount for ASC 842, as unidentified leases can lead to material misstatements.
Auditors evaluate the effectiveness of controls related to lease identification, classification, measurement, and ongoing accounting. They focus on how management identifies new leases, modifications, and terminations, and how these events are accurately reflected in the accounting system. For example, Deloitte emphasizes the importance of a well-defined process for identifying embedded leases and changes to lease terms, which can significantly impact financial statements 1.
| Assertion | Auditor Focus Area | Key Evidence |
|---|---|---|
| Completeness | Identification of all new and existing leases | Lease contracts, vendor invoices, general ledger review, contract database |
| Accuracy | Correct calculation of ROU assets & lease liabilities | Lease schedules, discount rate analysis, journal entries, accounting system |
| Valuation | Proper impairment assessment for ROU assets | Impairment analyses, fair value estimates, review of usage |
| Cut-off | Proper period for new leases, modifications, terminations | Contract effective dates, commencement dates, execution dates |
| Presentation & Disclosure | Compliance with ASC 842 footnote requirements | Financial statements, footnote disclosures, management representations |
⚠️ Risk Alert: A common audit finding relates to companies overlooking service contracts with embedded leases, leading to an understatement of lease liabilities and ROU assets. This directly impacts the completeness assertion.
Q: How do auditors test ASC 842 close process: complete monthly checklist? A: Auditors test the ASC 842 close process by examining documentation of control activities, performing substantive testing on lease populations and calculations, and corroborating management's assertions through external confirmations and analytical procedures. They often review a sample of contracts to confirm proper lease identification and classification.
Key Risks and Failure Points
Implementing and maintaining robust lease close procedures is critical for ASC 842 compliance. Numerous risks can lead to significant audit findings and misstatements if not properly addressed during the monthly close process. These risks often stem from a lack of clear processes, inadequate technology, or insufficient training.
- Failure to identify all leases: This includes overlooking leases embedded within service or supply contracts, which auditors will invariably test. The completeness of the lease population is a foundational requirement.
- Incorrect lease classification: Misclassifying finance leases as operating leases (or vice-versa) can materially distort a company's balance sheet and income statement presentations.
- Inaccurate discount rates: Using an incorrect incremental borrowing rate or implicit rate can lead to misstated ROU assets and lease liabilities, impacting interest expense.
- Errors in lease modification accounting: Changes to lease terms, such as extensions, contractions, or remeasurements, are complex and frequently mishandled, leading to calculation errors.
- Incomplete or inadequate documentation: Lack of clear audit trails for lease decisions, calculations, and inputs makes it difficult to support financial statement balances and disclosures.
- Failure to impair ROU assets: If an ROU asset's carrying amount exceeds its recoverable amount, an impairment loss must be recognized, a step often missed during the routine close when there's no specific trigger.
- Overlooking the ROU asset close procedures: This can lead to incorrect amortization, impairing the accuracy of financial statements.
Example Scenario: A manufacturing company uses numerous third-party logistics (3PL) providers. Their contracts for warehousing and transportation often contain provisions regarding dedicated space, specified equipment, and control over specific assets (e.g., forklift fleets). The accounting team initially only identified outright building leases. An auditor's sample of 3PL contracts revealed several embedded lease discovery instances, where the manufacturer had the right to control the use of identified assets (warehouse sections, specific trucks) for a period of time. This resulted in a material adjustment, as these embedded leases were not recognized under ASC 842, impacting both the balance sheet and income statement.
🚨 Critical: Failure to identify embedded leases can result in material misstatement and significant financial statement restatements, particularly for companies with complex service agreements.
Practical Checklist for Monthly ASC 842 Close Process
This practical ASC 842 close process: complete monthly checklist provides a structured approach to ensure accuracy and completeness. Each step is vital for robust lease accounting compliance.
How to ensure lease completeness for ASC 842 compliance?
To ensure lease completeness,
| Step # | Checklist Item | Key Action/Deliverable | Responsible | Reviewer | Status |
|---|---|---|---|---|---|
| 1 | Lease Data Integrity Check | Verify all lease data (e.g., terms, payments, discount rates) in the lease system is current and accurate. Confirm system updates for new leases, modifications, and terminations. | Lease Accountant | Accounting Manager | Done |
| 2 | New Lease Identification & Abstraction | Identify all new contracts and contract changes signed or commenced in the month. Abstract relevant lease data into the lease accounting system. | Lease Accountant | Controller | Done |
| 3 | Lease Modification & Termination Processing | Process all modifications (e.g., extensions, remeasurements) and terminations according to ASC 842 guidance. Ensure recalculations are performed and entries posted. | Lease Accountant | Accounting Manager | Done |
| 4 | Journal Entry Generation & Posting | Generate monthly lease accounting journal entries (ROU asset amortization, lease liability accretion, variable lease expense). Post to the general ledger. | Lease Accountant | Accounting Manager | Done |
| 5 | Lease Amortization & Accretion Calculation Review | Verify ROU asset amortization expense and lease liability accretion are calculated correctly by the system or manually. Spot-check calculations. | Accounting Manager | Controller | Done |
| 6 | Reconciliation of Lease GL Accounts | Reconcile ROU assets and lease liabilities in the general ledger to the detailed lease schedules; investigate and resolve discrepancies. | Lease Accountant | Accounting Manager | Done |
| 7 | Variable Lease Payment Analysis | Identify and record variable lease payments or contingent rentals not included in lease liability (e.g., common area maintenance, sales-based rent). | Lease Accountant | Accounting Manager | Done |
| 8 | Impairment Trigger Assessment | Assess ROU assets for impairment indicators. If triggers exist, initiate impairment testing and record adjustments. | Accounting Manager | Controller | Done |
| 9 | Disclosure Data Review | Review key data points that will feed into ASC 842 financial statement disclosures for accuracy and completeness. | Controller | CFO | Done |
💡 Key Takeaway: A comprehensive checklist helps ensure no critical steps are missed, providing a clear roadmap for monthly lease accounting activities.
How Accounting Teams Should Validate Their Approach
Validation is a critical component of the ASC 842 close process: complete monthly checklist controls. Accounting teams must proactively establish procedures to confirm the accuracy and completeness of their lease accounting outcomes. This involves not only checking calculations but also verifying the underlying data and assumptions. For robust validation, teams should integrate testing methods that mirror those used by auditors, ensuring management's assertions hold up under scrutiny.
To effectively validate, organizations should:
- Perform periodic reviews of contract populations: Beyond monthly new lease identification, conduct quarterly or annual reviews of vendor contracts, purchase orders, and capital expenditure requests to identify any missed embedded leases. This supports effective lease identification testing.
- Reconcile lease data to broader systems: Compare data in the lease accounting system against property ledgers, fixed asset registers, and general ledger accounts for consistency.
- Review discount rate appropriateness: Regularly reassess the incremental borrowing rate (IBR) or implicit rate used for new leases, especially in changing interest rate environments. Document the methodology and inputs for IBR determination.
- Conduct "what-if" analyses for modifications: Before processing, model the impact of significant lease modifications to ensure understanding and accuracy of the resulting accounting entries.
- Maintain comprehensive audit documentation: This includes abstraction summaries, discount rate support, journal entries, reconciliation workpapers, and management review sign-offs. Auditors rely heavily on comprehensive audit evidence to support balances.
- Seek external validation: Consider engaging third-party specialists for an independent review of complex lease accounting areas or for a general health check of the ASC 842 implementation.
The Financial Accounting Standards Board (FASB) emphasizes that entities are responsible for implementing appropriate internal controls over financial reporting to ensure compliance with reporting standards 2. This includes controls over the entire lease accounting lifecycle.
Q: How to identify embedded leases in contracts? A: To identify embedded leases, scrutinize service contracts or purchase agreements for the right to use an identified asset, control over its use, and a specific period of use. Look for clauses granting exclusive use of equipment, dedicated space, or options to extend or control the asset's operation.
Common Mistakes and How to Avoid Them
Even with a checklist, certain pitfalls commonly trip up organizations during the ASC 842 close process: complete monthly checklist controls. Understanding these mistakes and implementing preventative measures is crucial for a smooth close and clean audit.
| Common Mistake | Best Practice to Avoid | Impact on Audit/Risk |
|---|---|---|
| Delayed Identification of New Leases | Implement a structured intake process for all new contracts, involving procurement and legal early. Establish clear communication channels. | Understatement of ROU assets/lease liabilities; missed disclosure items. |
| Ignoring Lease Modifications | Develop a robust change management process. Regularly review current lease portfolio for changes and require prompt notification from business units. | Inaccurate balance sheet; misstated expenses. |
| Inconsistent Discount Rate Application | Document a clear policy for determining the incremental borrowing rate (IBR) or implicit rate. Centralize IBR calculation and approval. | Errors in lease liability/ROU asset valuation; challenges to audit evidence. |
| Manual Adjustments in General Ledger | Leverage lease accounting software to automate journal entry generation and ensure consistency. Manual postings increase error risk. | Reconciliation issues; lack of audit trail; higher risk of material misstatement. |
| Insufficient Review of System Output | Implement a detailed review process for all system-generated reports and entries. Spot-check calculations and verify reasonableness. | Over-reliance on software can mask errors; lack of substantive corroboration. |
| Inadequate Documentation for Audit Trail | Maintain a centralized repository for all lease contracts, amendments, discount rate support, and reconciliation workpapers. | Increased auditor inquiry; potential for audit findings; delays. |
Example: A mid-sized retail company relies on a spreadsheet-based system to track its leases. When a lease is modified (e.g., an early termination option exercised), a junior accountant manually updates the spreadsheet and prepares the journal entries. A common audit finding was that the what documentation is required for asc 842 close process: complete monthly checklist-related entries were often incorrect or incomplete, missing critical adjustments to the ROU asset or lease liability. This led to material misstatement of both the balance sheet and income statement. The best practice would be to utilize specialized lease accounting software which automates these complex calculations and generates an auditable trail, significantly reducing the likelihood of such errors.
🚨 Critical: Relying on manual processes for complex lease modifications is a significant risk factor and often leads to incorrect financial reporting.
Q: What are common ASC 842 close process: complete monthly checklist audit findings? A: Common audit findings include incomplete lease populations, incorrect discount rate application, erroneous lease modification accounting, and insufficient supporting documentation for ROU asset and lease liability balances.
What Strong Execution Looks Like in Practice
Strong execution of the ASC 842 close process: complete monthly checklist extends beyond mere compliance; it fosters operational efficiency and provides greater confidence in financial reporting. Organizations that excel in this area demonstrate a proactive, integrated approach to lease accounting. They embrace technology and prioritize cross-functional collaboration.
- Integrated systems: High-performing organizations use specialized lease accounting software that integrates with their Enterprise Resource Planning (ERP) system. This automates calculations, journal entries, and reconciliations, reducing manual effort and errors.
- Proactive lease administration: These entities have a centralized process for identifying, abstracting, and managing leases throughout their lifecycle. New leases are identified at contract inception, not just when payments begin.
- Dedicated resources: They allocate specific accounting professionals or a team with expertise in lease accounting to manage the monthly close process. This ensures specialized knowledge is applied consistently.
- Clear internal controls: Robust internal controls, as recommended by organizations like the AICPA, are embedded within the lease accounting process, covering everything from data input to ledger reconciliations 3. These controls are regularly reviewed and tested.
- Comprehensive documentation: All lease-related decisions, calculations, and reconciliations are meticulously documented and readily available for review. This streamlines the audit process.
Consider a multi-national technology firm with over 500 leases globally. Through strong execution, they implemented a centralized lease accounting platform that automates monthly calculations and journal entries. Their procurement and legal teams are required to submit all new contracts for lease accounting compliance review before execution. This robust process led to a decrease in their lease accounting audit findings by 60% within the first year post-ASC 842 adoption, demonstrating the benefits of a well-controlled and automated approach. Their auditors could easily trace all transactions, vouch for the completeness of the lease population, and verify the accuracy of the financial statements with minimal friction. This level of preparation reduces audit response times and significantly lowers audit fees due to efficiency.
✅ Best Practice: Organizations with strong execution maintain quarterly lease reviews and regular reconciliation procedures, leveraging technology to streamline processes and enhance data integrity.
Next Steps
Optimizing your organization's ASC 842 close process: complete monthly checklist is an ongoing endeavor that requires continuous improvement and vigilance. By focusing on process discipline, technology utilization, and robust internal controls, you can significantly enhance the accuracy and efficiency of your lease accounting. Review your current close procedures against this checklist and identify areas for enhancement. Consider investing in tools that automate lease accounting to reduce manual effort and improve data integrity.
Related Articles
- Guide to Lease Population Completeness
- Auditor's Guide to Evaluating ASC 842 Compliance
- Implementing Top 10 Lease Accounting Internal Controls
- ASC 842 PBC List Guide
