Navigate ASC 842 Audit Findings with Confidence

Navigating ASC 842 lease accounting has been a significant undertaking for controllers and accounting managers since its effective date. But the implementation phase was just the beginning. The real challenge now is maintaining accuracy and compliance, especially when the external auditors come calling. This article, responding to ASC 842 audit findings: a controller's playbook, offers a framework we've used with clients to understand, prevent, and address common audit discrepancies. It's designed to guide financial professionals in mitigating risks and achieving a clean ASC 842 audit.

We often see that despite significant efforts, many organizations still encounter audit findings related to ASC 842. These findings can derail financial reporting timelines, drain resources, and even shake investor confidence. This guide aims to equip controllers with actionable strategies to respond effectively and efficiently, moving beyond reactive fixes to proactive prevention.

Responding to ASC 842 Audit Findings: A Controller's Playbook

What Auditors Are Actually Looking For

When we're on the audit side, we approach an ASC 842 audit with a clear methodology, zeroing in on specific financial statement assertions. Our primary goal is to gather sufficient appropriate audit evidence that the financial statements are free from material misstatement. This means evaluating the design and operating effectiveness of internal controls over lease accounting and performing substantive procedures. We typically focus heavily on lease identification, classification, measurement, and disclosures. The completeness assertion regarding the lease population is often a top priority; we want to ensure all leases have been identified and recorded.

The completeness assertion is our objective to verify that all transactions and accounts that should be recorded have actually been included in the financial statements. For lease accounting, this is particularly crucial for identifying all lease liabilities and right-of-use (ROU) assets.

✅ Best Practice: A robust internal control framework for lease accounting is non-negotiable. Organizations we've worked with that have strong internal controls generally experience much smoother audits because their processes consistently yield reliable data and documentation. A PWC report on lease accounting often highlights the importance of documented processes and clear segregation of duties in preventing findings ¹.

Auditors will conduct various lease audit procedures, including reviewing contracts, recalculating lease liabilities and ROU assets, and scrutinizing disclosures. We often perform walkthroughs of the lease accounting process to understand how an entity identifies, classifies, measures, and accounts for its leases.

Key Risks and Failure Points

We've seen several common areas that frequently lead to audit findings under ASC 842. Understanding these risks is the first step in heading them off.

• Incomplete Lease Population: A primary risk, and one we encounter often, is the failure to identify all arrangements that meet the definition of a lease under ASC 842. This usually stems from inadequate embedded lease discovery processes. Many organizations struggle with contracts that aren't explicitly labeled as leases but contain a right to control an identified asset. Think about service contracts for warehousing, transportation, or IT equipment – they can frequently contain embedded leases.

• Inaccurate Discount Rates: Incorrectly determining the incremental borrowing rate (IBR) or improperly using the rate implicit in the lease significantly impacts the measurement of lease liabilities and ROU assets. Auditors will always scrutinize the methodology and support for the chosen rate.

• Incorrect Lease Term Determination: The lease term is a critical input, especially concerning optional periods (renewals or terminations). Judgments around the likelihood of exercising these options demand strong documentation and consistent application.

• ROU Asset Impairment or Reassessment Failures: We often find companies overlooking trigger events that require ROU asset impairment testing or failing to reassess lease liabilities and ROU assets promptly following changes in lease terms or scope. An ROU asset audit will specifically look for these reassessments.

An embedded lease refers to a lease component situated within a larger contract that may not be explicitly identified as a lease. Failing to identify these can lead to material understatements of lease liabilities and ROU assets.

⚠️ Risk Alert: A common audit finding relates to companies overlooking service contracts for embedded leases, leading to a material understatement of lease liabilities and ROU assets. This oversight can significantly impact financial statements. One study indicated that over 40% of companies initially missed embedded leases ².

Scenario: During a recent 10-K review, a manufacturing client we worked with had leased space in a data center for its servers under a general "IT Services Agreement." The agreement specified dedicated server racks and granted the company the right to control their use for five years. However, the company's lease accounting team only reviewed explicit property leases. We discovered this agreement and determined it contained an embedded lease, requiring the recognition of a material ROU asset and lease liability that were previously unrecorded. The absence of a robust lease identification audit process was the root cause. This perfectly illustrates the risks of an incomplete lease population.

Practical Checklist for Responding to Findings

When confronting an audit finding, a structured and evidence-based approach is paramount. This checklist provides a framework we recommend for controllers.

Q: How do I respond to an ASC 842 audit finding?

A: Our approach is always to respond promptly and systematically. First, understand the finding completely. Then, gather all supporting documentation, perform your own recalculations, propose a clear remediation plan, and communicate transparently with your auditors. Focus on factual accuracy and complete support.

This checklist helps in addressing the question of what documentation is required for responding to ASC 842 audit findings: a controller's playbook. For a comprehensive pre-audit review, see our ASC 842 pre-audit self-assessment.

How Accounting Teams Should Validate Their Approach

Validation isn't just about correcting isolated errors; it's about systematically verifying the robustness of your lease accounting processes. It’s crucial for how to ensure lease completeness for ASC 842 compliance.

1. Reconcile Lease Data Annually: We recommend conducting a complete reconciliation of your lease population annually against general ledger accounts (e.g., rent expense, property tax expense, fixed assets), vendor files, and budget documents. The objective of lease identification audit procedures is to confirm that all contracts meeting the criteria for a lease under ASC 842 have been captured. As per FASB ASC 842-10-15, a contract contains a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration.

2. Embedded Lease Review: Implement a rigorous, periodic review of all non-lease contracts, including service agreements, procurement contracts, and IT agreements, for potential embedded lease discovery. It's critical to train procurement and legal teams on identifying lease indicators within contracts.

3. Discount Rate Consistency & Support: Ensure your incremental borrowing rate (IBR) methodology is well-documented, consistently applied, and recalibrated as market conditions or company credit ratings change. Always maintain clear support for all rates used.

4. Lease Term Judgment Review: Regularly review assumptions made regarding lease extension and termination options. Document the rationale for these judgments, tying them to economic incentives or penalties.

5. Control Effectiveness Testing: Test the operating effectiveness of internal controls related to lease accounting. This should go beyond mere existence and confirm that controls are functioning as intended. This includes controls over data input, calculation accuracy, and changes to lease terms. For detailed guidance, refer to our article on implementing top 10 lease accounting internal controls.

💡 Key Takeaway: Proactive validation significantly reduces the likelihood of audit findings. By mirroring auditor procedures internally, accounting teams can identify and resolve issues before the external audit begins.

Common Mistakes and How to Avoid Them

Even with robust processes, we've observed certain pitfalls that frequently lead to audit findings. Recognizing these "common responding to ASC 842 audit findings: a controller's playbook audit findings" helps significantly in prevention.

Q: What are the steps to address lease accounting audit findings?

A: The main steps we advise include confirming the exact nature of the finding, thoroughly reviewing relevant contracts and data, conducting any necessary recalculations, preparing proposed journal entries, developing a remediation plan for future prevention, and then communicating these resolutions clearly and proactively to the auditors.

🚨 Critical: From our experience, failure to identify and account for all leases, particularly embedded leases, remains a critical area for audit findings. This oversight directly impacts the completeness assertion and can lead to a material misstatement of financial statements because it underestimates the company's financial obligations and assets.

Example: A mid-sized retail company we advised recently discovered an audit finding related to the incorrect initial measurement of ROU assets. The issue stemmed from using a single, static incremental borrowing rate for all leases across different currencies and geographies. The remediation required recalculating all lease liabilities and ROU assets using appropriately segmented IBRs, leading to a significant prior-period adjustment. The company responded by implementing new internal controls over discount rate determination as part of their responding to ASC 842 audit findings: a controller's playbook controls. The enhanced controls now require an annual review by a dedicated finance team member and sign-off by the controller.

What Strong Execution Looks Like in Practice

Strong execution in lease accounting compliance translates directly into more efficient audits and, crucially, fewer findings. For a controller, this means less time spent on remediation and more on strategic financial management.

Organizations that demonstrate strong execution typically exhibit:

• Comprehensive Lease Inventory: A centralized, up-to-date database of all lease contracts and amendments.
• Automated Lease Accounting Software: Leveraging technology to handle complex calculations, generate reliable amortization schedules, and facilitate disclosure reporting.
• Documented Processes: Clear, well-communicated policies and procedures for every aspect of lease accounting, from identification to derecognition.
• Cross-Functional Collaboration: Regular communication between accounting, procurement, legal, and operational departments to ensure all leases and embedded lease components are identified.
• Proactive Review and Reconciliation: Monthly or quarterly reconciliations and internal reviews to catch errors before the audit team does.
• Qualified Personnel: Staff with adequate training and expertise in ASC 842 requirements.

When we, as auditors, encounter an organization with these characteristics, the audit process becomes much more collaborative and less adversarial. For instance, Deloitte's guidance on ASC 842 implementation consistently emphasizes the role of technology and well-defined controls in achieving compliance and audit readiness³. A well-prepared company can quickly provide requested documentation, confidently explain its accounting judgments, and present a clear audit trail. This often results in minimal findings, and any identified issues are usually minor and easily resolved.

Next Steps

For controllers and accounting managers, continuous improvement in lease accounting is essential. We encourage you to review your current processes against the best practices outlined in this playbook. Invest in staff training and appropriate technology to strengthen your control environment and enhance data accuracy. Proactively addressing potential weaknesses will not only streamline your next audit but also ensure ongoing compliance.

Related Articles

• Guide to Embedded Lease Identification
• ASC 842 Audit Checklist for Controllers
• Understanding ROU Asset Calculations
• Continuous Lease Compliance