Discovering Missing Leases: A Systematic Approach

How to Systematically Uncover Hidden Leases for ASC 842

A systematic search for missing leases is critical for any company that wants lease accounting compliance under ASC 842. The work is to confirm that the company has identified, assessed and recorded every contract that meets ASC 842's definition of a lease. That is the completeness assertion, applied to the lease population.

A systematic approach makes sure the team overlooks no material lease contract. That keeps financial misstatements and audit findings to a minimum.

A company that fails to find all of its leases faces real consequences. The right-of-use asset and lease liability are understated. The disclosures ASC 842-20-50 requires cannot be given in full. Debt covenant ratios get computed off the wrong balance sheet, and a restatement follows if the lease is material and surfaces after the statements are issued.

This article sets out the methods and controls a company needs so that no lease goes unfound. A robust method is essential to avoid the pitfalls of an incomplete lease population and to be ready for an ASC 842 audit. To reduce these risks, companies should build a completeness process well ahead of the audit.

For a complete breakdown, see our ASC 842 compliance guide.

How Auditors Challenge Your Lease Population

Auditors approach lease completeness with a great deal of skepticism. They focus on the completeness assertion. That term refers to the auditor's goal of verifying that the financial statements include all transactions and accounts that should be recorded. They aim to confirm that the company has properly found and accounted for every contract that meets the definition of a lease.

This involves detailed lease audit procedures. These aim to uncover leases that are stated outright, and to find leases embedded in other contracts. Auditors will look hard at the methods the company uses to identify leases. They pay close attention to the documents and to internal controls.

🚨 Critical: A company that fails to find embedded leases can materially misstate the right-of-use (ROU) asset and lease liabilities. That misstatement leads to large audit adjustments.

Auditors typically focus on several key areas to ensure completeness:

• Contract Reviews: Auditors look at a broad range of contracts beyond the usual lease agreements. These include service contracts, purchasing agreements, and utility contracts. An embedded lease is a lease component that sits inside a larger contract and may not be spelled out as a lease.
• Systematic Search Procedures: Auditors verify that management has a documented, repeatable process to find new and existing contracts.
• Interviews: Auditors discuss purchasing practices, capital spending approvals, and real estate management with the relevant staff across departments.
• Data Analytics: Auditors use data from general ledger accounts, vendor payment registers, and capital spending budgets to find leases that may not be on the books.

A company often needs a team drawn from more than one discipline to find all of its leases. That team involves accounting, procurement, and legal staff. Auditors expect to see strong internal controls over this process, with checks and balances that keep leases from being left out.

Deloitte's Roadmap: Leases lists "All leases are not identified, in accordance with company policies" among the lease risks a control environment has to address¹.

Key Audit Focus Areas for Lease Completeness

Q: How do auditors test whether the lease population is complete? A: Auditors test the completeness of the lease population. They review how management finds leases, perform substantive procedures like contract sampling, and reconcile lease data with financial records. That includes checking non-lease contracts for hidden lease components and judging how well internal controls over lease accounting work.

Material Misstatement From Undiscovered Leases

The risks of an incomplete lease population are large. Leases that go unfound can lead to material misstatements on the balance sheet and income statement. Those misstatements affect key financial ratios and compliance with debt covenants. For auditors, this is a control deficiency whose severity they then evaluate.

• Material Misstatement: The main risk is that the balance sheet will understate the ROU asset and lease liabilities, while the income statement will misstate lease expense. This directly affects how accurate the financial reports are.
• Disclosure Inadequacies: Without a complete lease population, a company cannot give the disclosures ASC 842-20-50 requires. If the omission is material and the company does not correct it, the auditor modifies the opinion.
• Restatements: Finding a missed lease after the financial statements are issued can force a restatement that is costly and hurts the company's reputation. That erodes investor confidence.
• Inaccurate Debt Covenant Compliance: Understated lease liabilities can falsely show that the company meets its debt covenants. That can trigger defaults if the true liability later comes to light.
• Ineffective Internal Controls: A failure to find all leases is a deficiency in internal control over financial reporting. For issuers under Section 404(b), a material one can force an auditor's adverse opinion.

How severe that deficiency is depends on which framework the audit follows. PCAOB AS 2201 applies to audits of issuers. It defines a significant deficiency as one "less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the company's financial reporting" (paragraph .A11).²

A material weakness is a deficiency, or a combination of deficiencies, creating "a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis" (paragraph .A7). Only a material weakness forces an adverse opinion on internal control, and that opinion exists only for SEC filers subject to Section 404(b).

A private company's auditor communicates deficiencies to management and those charged with governance.

⚠️ Risk Alert: A common audit finding involves companies that overlook service contracts with dedicated equipment, staff, or use of specific property. These contracts often contain embedded leases that change the ROU asset balance auditors test.

Example: A manufacturer signs a five-year contract with an IT vendor. The vendor owns the server and specifies it in the contract by serial number. It installs the server for the manufacturer's exclusive use at the manufacturer's plant and provides repair and maintenance throughout the term. The vendor may substitute the server only if it malfunctions.

That server is an identified asset. An asset "typically is identified by being explicitly specified in a contract" under ASC 842-10-15-9, and this one is named by serial number. A substitution right the vendor can exercise only on malfunction is not substantive.

The manufacturer has exclusive use of the server for the five years, so it obtains substantially all the economic benefits from its use (ASC 842-10-15-4(a)). It decides which data the server stores and how the server fits into its operations. It can change those decisions during the term, so it directs the use (ASC 842-10-15-4(b) and 842-10-15-20(a)).

Both limbs are met, so the contract contains a lease under ASC 842-10-15-3 even though both parties call it a service agreement. The Codification reaches the same conclusion on materially the same facts at ASC 842-10-55-127 through 55-130 (Example 10, Case B), where the term is three years.

Suppose the accounting team books the whole invoice as IT expense and never identifies the lease. The manufacturer never recognizes the right-of-use asset and lease liability that ASC 842-20-25-1 requires at commencement. It understates both, a potential material misstatement an auditor would find while testing the ROU asset.

Change one fact and the answer flips. If the vendor had installed ten servers to deliver a network service, it would choose how to deploy them. It could reconfigure or swap any of them to hold the service level. The vendor, not the manufacturer, would direct their use, and there would be no lease (ASC 842-10-55-124 through 55-126, Example 10, Case A).

Dedicated equipment sitting on your own floor is not by itself a lease. What decides the question is who makes the decisions about the asset.

Practical Checklist for Discovering Missing Leases

Identifying embedded leases in contracts efficiently takes a methodical approach. This checklist gives a framework for a systematic search for missing leases.

✅ Best Practice: Automate the workflow for new contracts. That makes sure each one gets a systematic review to catch embedded leases before it is signed or shortly after.

How do I find all my company's leases?

A thorough search for all your company's leases uses a strategy with several prongs. Start by bringing all contracts into one place across departments, including procurement, IT, real estate, and legal. Run keyword searches on digital contracts for terms that point to leases.

Interview department heads about asset use and recurring service agreements. Finally, reconcile general ledger accounts and vendor payment lists against your current lease register to spot leases that may have been left out.

Proving Your Identification Process Is Sound

Accounting teams must be able to show that the way they identify leases holds up. That is what demonstrates robust internal controls and a thorough search for missing leases. Validation means not just finding leases but proving the process behind them is documented and repeatable. It means showing what documentation the process produces.

• Process Documentation: Develop and maintain clear, written procedures to find leases. Include roles, duties, and flowcharts for decisions. These documents should set out how the team reviews new contracts and looks again at existing contracts on a regular basis.
• Sampling and Testing: Test in-house by taking a sample of non-lease contracts or expense line items and reviewing them for embedded leases. Record the results and any fixes made.
• Regular Reviews: Review the entire contract population each quarter or each year. This matters most for companies with high contract turnover or where purchasing is spread across the business.
• Technology Utilization: Use lease accounting software that has features for contract abstraction and for spotting embedded leases. This makes the work more efficient and consistent. For more on using such tools, see our guide to the Top 10 Lease Accounting Internal Controls for Success.
• Cross-Functional Collaboration: Evidence that accounting talks and works regularly with legal, procurement, and operations teams on finding leases makes the validation stronger.

Calculation Example: Impact of an Undiscovered Lease

Scenario: A company fails to discover a 5-year equipment lease with annual payments of $10,000, payable in arrears. The discount rate is 5%, the lessee's incremental borrowing rate, because the rate implicit in the lease is not readily determinable (ASC 842-20-30-3). A lessee that is not a public business entity may instead elect a risk-free rate, by class of underlying asset.

The missed lease causes the company to understate the ROU asset and lease liability.

Key Takeaway: Because of the missed lease, the balance sheet at commencement understates both the ROU asset and the lease liability by about $43,295. The two are equal here because there are no payments at or before commencement, no initial direct costs and no incentives (ASC 842-20-30-5). That is a material amount for many entities.

An auditor running substantive analytics on rent and equipment expense would spot the recurring $10,000 that never reached the lease schedule. So would a reconciliation of the vendor payment register to the lease register.

There is no deferred rent account to look in. On transition to ASC 842 a lessee folds prepaid or accrued lease payments into the right-of-use asset (ASC 842-10-65-1). Under ASC 842-20-35-3(b)(1) the ROU asset carries the timing difference ASC 840 parked in deferred rent.

Why Procurement Teams Miss Leases in Contracts

Even with detailed procedures, companies make common errors when they try a systematic search for missing leases. These mistakes often become audit findings.

💡 Key Takeaway: Poor training across departments is a widespread problem. Procurement teams often fail to spot the traits of a lease inside broader service contracts.

Many companies struggle to find subtle lease components. The "identified asset" test is where most of these judgments turn. An asset is identified if it is explicitly or implicitly specified (ASC 842-10-15-9) and the supplier has no substantive right to substitute it.

ASC 842-10-15-10 makes a substitution right substantive only if two conditions hold. The supplier must have "the practical ability to substitute alternative assets throughout the period of use". It must also "benefit economically from the exercise of its right to substitute the asset" - quoted in PwC's Leases guide, section 2.3⁵. If the supplier can swap the asset at will and would benefit from doing so, there is no identified asset and no lease.

For instance, a contract for IT managed services might include the right to use specific servers, even if the vendor provides the services. The test is who makes the decisions about the asset, not where it sits. Where the vendor chooses how to deploy the equipment to hit a service level, the vendor directs its use and there is no lease (ASC 842-10-55-124 through 55-126).

Overlooking this detail can lead to a material audit finding. Our guide to Common Lease Abstraction Errors and Their Financial Impact gives further insight.

Integrating Lease Discovery Into Contract Workflows

Companies that run a systematic search for missing leases well have a mature process that fits into daily operations. Their approach is not a one-time project but an ongoing system. It helps keep lease accounting compliance reliable.

Such companies usually show:

1. Integrated Workflows: Each new contract automatically triggers a review for lease components by trained staff. This often involves automated alerts inside contract management systems.
2. Centralized Lease Repository: The company stores all lease contracts and relevant non-lease agreements in a single database that is easy to reach. This makes searches efficient and allows review of past records.
3. Dedicated Lease Accounting Software: Tools built just for ASC 842 help the team find, abstract, and manage leases. They greatly reduce manual errors and improve completeness. For auditors, this means audit trails and reports that are ready at hand.
4. Regular Training and Communication: Departments like procurement, IT, and real estate get ongoing training on the signs that point to a lease. This builds a culture of compliance.
5. Proactive Internal Audits: The internal audit function tests the completeness assertion for leases on a regular basis. This adds a layer of assurance before the outside auditors arrive.
6. Readiness for External Review: When auditors conduct an ASC 842 audit, the accounting team can promptly hand over every document asked for. The team can show how it finds leases and answer questions with confidence. This smooth process reflects strong lease accounting compliance.

Refining How Your Team Finds Leases

Keeping the lease population complete under ASC 842 is ongoing work that takes a constant watch and robust internal controls. Controllers and accounting managers should regularly review and refine how they find leases. It is paramount to reach out early to every department that enters into contracts. Consider using software tools to streamline your approach and improve accuracy.

Related Articles

• Completeness Testing Procedures for Lease Populations
• ASC 842 Audit Readiness Checklist
• ASC 842 Audit: Guide to Compliance Evaluation
• Preparing for ASC 842 Audits