An internal control – as defined by accountants and auditors – is a process to ensure the achievement of an organization’s objectives in operational effectiveness and efficiency, reliable financial reporting, and compliance with laws, regulations and policies. Internal control involves everything that controls risks to an organization.
In light of the new lease accounting standards, leases play a more significant role in your financial disclosure, which means there is increased risk around the accounting of those leases. Additional scrutiny in the design and effectiveness of internal controls is required to mitigate this risk. You now need to take a holistic view of the full lifecycle for all your leases and refine the controls and other processes related to identifying, calculating and accounting for them.
Numerous aspects of the new standards are causing concern among corporate executives, but it’s safe to say the control issue is top of the list for many. In a KPMG survey in November 2017, 500 finance executives were asked what was keeping them up at night, and internal controls over financial reporting topped the list at 30 percent, compared to 21 percent in 2016. And the impending changes to the new lease accounting standards are one of the underlying causes of that increase.
“The focus on internal controls is especially important to ensure that reported financial information has the appropriate checks to ensure reliability and accuracy. It should be central to all financial reporting efforts.”
John Ebner, KPMG’s National Managing Partner of Audit
What are the key areas of control consideration under the new standard?
Lease Negotiation and Accounting
Historically your company may have been negotiating leases and accounting for them on a decentralized basis, but it may be worth reviewing. While it made sense for you to control and monitor operating leases at the business unit or functional level when they were classified and treated as an expense along the lines of service agreements, now that these leases are moving onto the balance sheet under FASB ASC 842, centralizing these functions may ensure better controls.
Whether you have a centralized or decentralized process, it may be wise to establish or enhance controls around capturing all needed information when new leases are signed and during the ongoing maintenance of the lease inventory. You’ll need to consider the different types of leases and establish workflows with appropriate reviews and approvals, as well as maintain an audit trail for any decisions and interpretations made along the way.
When leveraging systems to manage your leases, you’ll need to establish controls over the source data and any interfaces or transfers to ensure data integrity. Additionally, as these systems will perform financial calculations in support of the FASB ASC 842 standard, system access controls and segregation of duties will eliminate errors and potential fraud. Under the Sarbanes-Oxley Act, companies are required to perform a fraud risk assessment and assess related controls. Additionally, reviews and approvals through workflows will add a layer of responsibility to accounting records by proving that transactions have been seen, analyzed and approved by appropriate authorities.
Third Party Suppliers
In some circumstances, aspects of your lease portfolio are actually managed by a third-party supplier, and your ability to know when your leases have changed – i.e. are modified, renewed, extended or cancelled – can be compromised. You need to ensure that not only do you have complete information at the start, but that any modifications are communicated as soon as they happen. You need to enact robust processes for tracking, reviewing and approving these changes.
Ongoing Risk Management
With change comes risk, and your organization must consider any risks related to this regulatory change both now and in the future. This means there must be an ongoing process to monitor any controls you have implemented, and a process to modify them should you identify any areas of risk.
To make sure enhanced controls related to your leases are implemented properly, companies are wise to document the design and implementation stages. Proper planning and documentation can heighten the confidence management, auditors and audit committee members have that the controls are solid. There is some evidence that with these new standards will come enhanced scrutiny from your auditors, who are expected to improve their control testing. Getting robust control systems in place, as well as documented and tested, will ensure you are well positioned for any ASC 842 scrutiny.
Visit our lease compliance resource center tangoanalytics.com/roadtoleasecompliance for more information.