Lease Errors Start in the Process: Seven Questions a Private Company CFO Should Ask
Questions this article answers
- What causes lease accounting errors at private companies?
- What should a CFO ask about lease accounting?
- Do private companies need internal controls over leases?
Lease accounting errors at private companies often start in the process, not the math. A lease nobody told accounting about produces wrong numbers from correct formulas. So does an amendment that never reached the schedule, or a discount rate nobody can support. That makes leases a controls question for the CFO, and seven questions will show you where you stand.
Why this reaches the CFO's desk
ASC 842 moved operating leases onto the balance sheet (ASC 842-20-25-1). For many private companies, that made the lease liability one of the larger obligations on the page. It also means an error now touches a number that outside readers rely on.
Being private does not take the issue away. The Sarbanes-Oxley management report on internal control applies to public companies, and the auditor attestation only to larger filers. Your financial statement auditor still has to understand your system of internal control (AU-C 315).
If the auditor identifies a significant deficiency or material weakness, it must be communicated in writing to those charged with governance (AU-C 265). For a private company, that often means the board or the owners (AU-C 260).
Your lender may care too. Credit agreements define debt and leverage in their own terms, and some treat operating lease liabilities differently than others. Read yours, because a misstated lease balance can feed straight into a covenant calculation.
Seven questions to ask your controller
None of these requires you to know the standard. Each one has an answer that should come with evidence.
| Question | A weak answer | A strong answer |
|---|---|---|
| 1. How do we know we have every lease? | "We have all the ones the team sent us." | A documented check against expense accounts and contracts, including service contracts |
| 2. Who tells accounting when a lease changes? | "Real estate usually lets us know." | A named owner, and a question asked every close |
| 3. Where did our discount rates come from? | "The same rate we used last year." | A written policy and support for each rate |
| 4. Does the lease detail tie to the general ledger? | "It should. We check it at year-end." | A reconciliation each close, with items explained |
| 5. Who reviews lease entries before posting? | "The person who prepares them." | A second person, with evidence of the review |
| 6. Could someone else do this next month? | "Only one person knows that spreadsheet." | A documented process in a system others can use |
| 7. What would our auditor ask for, and how fast could we produce it? | "We start pulling it together at fieldwork." | The rollforward, support and footnote data ready to run |
What sits behind the main questions
Completeness comes first
A lease that was never entered creates no error message. A company must determine at inception whether a contract is or contains a lease (ASC 842-10-15-2), and that includes leases inside service contracts. Those are the ones a lease list built from the real estate file will miss. Our guide to common lease control deficiencies shows how this one tends to surface.
Changes are where good schedules go stale
An amendment, a renewal decision or an early termination can each change the accounting. A modification that is not accounted for as a separate contract, and that adds a right of use, changes the lease term, ends all or part of the lease, or changes the consideration, requires the lessee to remeasure the lease liability at a discount rate determined at the modification's effective date (ASC 842-10-25-11). The people who negotiate these changes rarely think of telling accounting, so the process has to ask them. See our guide to lease modifications and remeasurement.
Discount rates are judgments that need a file
A lessee uses the rate implicit in the lease if it is readily determinable, and otherwise its incremental borrowing rate. An entity that is not a public business entity can elect a risk-free rate instead of its incremental borrowing rate, by class of underlying asset (ASC 842-20-30-3). The company needs to be able to show which it used and why. The election also has a balance sheet effect, covered in our guide to the risk-free rate election for private companies.
Reconciliation is the cheapest control you have
Comparing the lease detail with the general ledger each close finds many errors while they are still small. Our guide to what auditors expect from a lease subledger walks through a tie-out with numbers.
One person and one spreadsheet is a risk in itself
Small teams cannot always split every duty, and an auditor understands that. The question is whether someone with enough knowledge reviews the work, and whether the process survives if the preparer leaves.
What to do with the answers
Start with the weakest answer, not the longest list. Usually one or two fixes carry most of the risk:
- Assign a named owner for the lease list and for reporting lease changes.
- Add one lease question to the monthly close checklist.
- Reconcile the lease balances to the general ledger each close, not only at year-end.
- Require a second person to review new leases and modifications.
- Ask your auditor now what they will want at year-end, and raise anything you already know is weak.
For a fuller structure, see our ASC 842 internal control framework.
Where lease accounting software fits
Software removes spreadsheet risk from the calculation and leaves a record of how each number was built. It cannot tell you about a lease nobody entered, and it cannot own your accounting judgments.
iLeasePro saves the answers from its classification wizard with each lease. It produces a subledger trial balance that a controller can check before entries reach the general ledger. It is also covered by an annual SOC 1 Type 2 examination. If you are weighing a move off spreadsheets, our lease accounting software pricing is published, and you can request a demonstration.
Sources and further reading
- Deloitte, Roadmap: Leases.
- AICPA, Statements on Auditing Standards (currently effective), AU-C 260, AU-C 265 and AU-C 315.
- US Securities and Exchange Commission, Release No. 33-9142, on Section 404 attestation.
- FASB Accounting Standards Codification, Topic 842, Leases.
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