what's up audit fans today we're going to get into a topic that has been requested quite a lot which is auditing leases and today we're going to look from the lessee's perspective not the lessors perspective ifrs 16 resulted in a lot of changes with leases and that came in in 2019 and that saw billions of dollars of previously unrecognized leased assets now coming onto the balance sheet as well as lease liabilities so there's certainly lots of complexity in valuing those leases and making sure that they're appropriately recorded so today we're going to get into the auditing part of leases i'm not going to go into the accounting technical aspects of it there's certainly lots of videos on youtube that can help you with the accounting perspective but today we're going to look into the auditing perspective so let's get into it what's up audit fans welcome back to amanda loves to audit for my regular subscribers hi if you're new my name is amanda i do love audit and i teach audit at an australian university to undergrads so today we're looking at leases and i'm not going to do the accounting treatment of leases you can look at any ifra16 video on youtube i'll link some in the description that are really i found good in terms of helping my students understand leases today we're going to look at the audit perspective but we also need to think about the process so remember asa isa 315 says we need to understand the processes and this is really critical because if a company has automated processes or manual processes once we've identified those processes then we can test the internal controls so when it comes to auditing leases you know we first need to start to look at the process so let's go through what that process is normally there's got to be some sort of process to request a leased asset you just can't lease one in a company yourself so there's going to need to be some sort of approval of that request there's probably going to be a process to get quotes from different companies who supply the leased asset to help you out there once you've got a quote then there's probably going to be some form of contract now it's really important here that the contract is reviewed by someone probably someone from a legal perspective to make sure that there has been that legal review then the parties to the contract need to sign the contract and then we need to handle the accounting processes all right so we need to record the event in accounting now from the accounting perspective i guess there's a couple of different things that we do need to consider when we're looking at the accounting process number one there needs to be a process to add the asset potentially to the fixed asset register to the far fixed asset register and hopefully you know most fixed asset registers these days have the ability to recognize an asset that you own versus an asset that you lease so you need to make sure that there's that component there so you need to add the asset to the fixed asset register you're going to need to make sure that you create the liability ll is the lease liability there [Music] and then also there's going to need to be a process for your regular journal entries and those regular journals are going to be about the payments because remember you have to make payments for your lease and also recording depreciation because it is a leased asset and has its own liabilities so in terms of testing the internal controls here this is where it becomes really important to make sure that you understand what are the controls in place what are the processes in place so that then you can test those controls so isa asa 315 is really critical here in understanding the client so here what becomes really important now is deciding what is going to be the audit strategy so if this is a company that has lots of leased assets and there are lots of new leases coming and going and you probably couldn't audit all of them just like with bank loans it probably makes sense to test the internal controls and then do some substantive testing if the company has like five leased assets and they didn't add any new leases this year then you wouldn't even bother really testing internal controls you just go straight to the substantive evidence but you know you need to look at the volume of the transactions the value of them to decide whether you're going to go with that tester control strategy or the substantive strategy or a mix of both now for most publicly listed companies large companies companies that need a big audit you're going to probably look at both of those aspects do a mix of those tests of controls and substantive tests so in terms of substantive tests here we need to look at the process what is your client process under isa asa 315 so that we can identify the controls so you know we're going to do things like look at the approval process so it could be things like select a sample of leased assets and check there oops that's not how i spell that type of there there was uh reviewed or i should say is was is a reviewed contract that was signed all right you want to make sure that the contract was signed so you've got a binding agreement there and that it was reviewed because remember the reviewing helps make sure that it's legally you know everything is okay for the client so it's as simple as selecting that document inspecting the document and making sure everything is correct so that you make sure that each item really has been through that approval process now you're probably going to spend more time looking at these accounting procedures and the controls around accounting than the controls around the general lease process so for example when you need to add an asset to the fixed asset register create the liability there's going to probably need to be a process where you review a sample of documentation to add the asset add the least asset la and the least liability all right because that's going to be there's going to be a lot of calculations in there we're not going to redo the calculations but was the documentation reviewed and approved before the asset and the liability were created all right we're going to get into the details more of least asset at least liabilities a little bit later on so we want to make sure that you know when you oh we've got a new leased asset oh great here is all the information we need i've prepared the journal entries has somebody reviewed those before that they've been posted now when it comes to the regular journals again we want to find out uh this might be an automated process or it might be a manual process now if it's an automated posting process where things are automatically going out you know as soon as you make the bank payment the journal entry occurs then we need to look at the controls over that process so who sets up the automated journal entries and approves for any manual journal so they manually prepare the journal then our proposed journals reviewed before posting now we also want to look at here you know the questions of segregation of duties who can do these tasks and then what can they do so not everyone might have access to the fixed asset register and some people on the fixed asset register might only be able to create or view you might not be able to delete anything so you want to check those roles and responsibilities as well when it comes to that segregation of duties component now when it comes to substantive procedures this is where it gets a little bit more complicated because with our substantive procedures we have two components the first one is that we have our least asset and our lease liability all right and those are items that are going to be on the balance sheet so they have balance assertions to worry about the other thing to consider is that our consideration our payments to the company that we're leasing from have to happen and we also need to record depreciation which means that we're going to have to worry about the transaction assertions so i'm going to split these up and i'm going to do them separately depreciation i'm not going to handle so much you can look into my property plan equipment video for ideas and on how you can test depreciation because the process works exactly the same so let's start with the least assets and the lease liabilities and i'm going to firstly write down the assertions now i always recommend starting from the assertions and then building procedures off that don't build procedures and then go oh have i covered all the assertions because it's very likely that you're going to miss something so i always start from that assertions based approach so for existence remember existence is we're going to be vouching something and start with the records and go back to the original source of the transaction or the documentation so here i'm going to select a sample of my leased assets las from the fixed asset register all right and vouch so track so go backwards vouch to the physical asset okay that's going to tell me that there's an item it really does exist and also match to the lease contract now why do i want to go back and make sure that there's a contract because i want to make sure it's definitely a leased item and not an item that they own so we want to make sure that there is um that component so normally if i'm checking ppe for example i'm just vouching from the records back to the physical item but i want to make sure that there's also that contract involved now in terms of sample selection when you're sampling you could use haphazard you could use block you could use random but you know pick a specific sample method that suits your particular population and your test now when it comes to thinking about which of these are probably most at risk the assertions most at risk i'd be worried about is going to be that accuracy completeness and rights and obligations less so existence but the other three i think in in my perspective are the things that we're worried about the most so with completeness it's i'll be under reporting so usually we trace here so we're going to select a sample of physical least assets i can just write la there i don't need to las and trace so move forward so start from the physical item and follow it through to the lease contract and records in the fixed asset register all right we want to make sure that least asset and how would you figure out which ones might be at least asset when you're looking at the you know assets in the building your leased assets might have a separate color barcode or something else that would help us identify them now the other thing about trying to potentially identify under report under-reported leased assets might be to do some analysis of payments so analyze payments for lease exemptions now there are two areas in which you may have an exemption for a lease and that is an asset that is going to be leased for less than 12 months we just have an expense or an asset that is low value when you first bought it but you're still leasing it so like you're leasing something that's maybe 200 that's low value you can just include you don't have to worry about recording the least asset so we might want to analyze payments for these exemptions and review the contracts the lease contracts to make sure it is an exempt item and should not be recorded because and this is where you know we sort of have some crossover with rights and obligations you might have something that is low value that you might you know this your entity or the client that you're auditing says this is low value um but in your perspective you have to look at that and say look is it really low value you're leasing it for five years uh there's decent residual value at the end so you need to go through those exemptions and make sure that none of them should actually be leased assets so that's one thing to do there now accuracy valuation and allocation is going to be really complicated the accuracy side that accuracy part is really about your depreciation and accumulated depreciation now if you see me write dp apostrophe n or dp and that's depreciation so you can look at my property plant and equipment video for the stuff about accuracy but valuation is where it really becomes complicated because remember you've got your liability your lease liability and you've got the least asset now the lease liability is the present value of the future payments using the interest rate from the contract or some sort of other rate that implies you know a rate of borrowing or something so you have to figure out that present value now the client might use software to do this when they put the payment in you have to be careful if the payment increases over time so if there's a cpi increase component in there to recalculate the the present value so that's the present value which means that one of the things that you might need to do here because it's the present value is to recalculate so what you're going to do here is recalculate the present value of the future payments and then reconcile to the value recorded in the accounts all right so you want to make sure that that lease liability is there now when it comes to the leased asset at least asset i'll write the full thing there that's where again more complication because the least asset value is the least liability plus any initial sort of setup costs plus any cost to dismantle or remove the asset at the end so that's the value of the leased asset so to be able to actually audit that again we're going to need to recalculate the la leased asset value using the contract all right because that'll have all the important information and reconcile that reconcile to the fixed asset register okay and and that's where it's going to need to be really important you're also going to need to uh check accumulated depreciation is being recorded appropriately but you're going to get that from when you're auditing the the ppe depreciation side of things okay so we've covered valuation now the other thing we need to think about is allocation and remember that is because most of these things should be in the non-current category so your leased assets are likely to be non-current assets because if it was a current asset then it's not really worth leasing so they should be non-current assets and then also non-current liability so you've got the asset side and you've also got the liability side and this is where it gets tricky because the liability is broken into what you owe into the future and then what you owe into the next 12 months the next 12 months actually should be recorded as a current liability and then anything after 12 months should be a non-current liability so you need to inspect the records and look at what's on that balance sheet to make sure that they're apportioned and allocated correctly and then we have rights and obligations now remember write to recognize the asset obligation to recognize the liability so again here we're going to be reviewing lease contracts and we're going to be looking for information about do we control the asset do we receive benefits and also do we have responsibilities all right so we're making sure that this really is you know a proper lease and that we have our obligations and our rights in there remember earlier i mentioned a little bit further up that when we're looking at completeness you know if we have some smaller leased items that are exempt again we want to make sure they're properly examined so remember that ifrs 16 cut out the distinction between financial and operating leases they're all just financial leases now unless they meet those two exemptions so we need to make sure that companies aren't trying to record items just as operating leases when they really should be financing leases so we really need to go back and look at that and this was important because when we saw ifra16 or double asb 116 coming in in australia i think there's i read an estimate somewhere that like 100 billion dollars worth of assets and liabilities were added to balance sheets which again threw off a lot of ratios for a lot of firms so that is least assets and the least liability side now we need to go on to the other side which is going to be about the depreciation and the payments now remember i mentioned before i'm not going to go too much into the depreciation section but i am going to talk about here the payment side all right so in terms of our assertions of course i'm going to start by writing them out all right so again this is no different than any other accounts payable i haven't put that in my video series yet but it's coming so we're going to do things like vouch a random sample of lease payment journals to now they might invoice you if there's a lot to invoices or contracts all right so proof that you know we really do have an arrangement to make these payments to the suppliers because remember when you make a payment you're going to go debit uh your lease expense credit cash okay so we want to select a sample of those so that's the occurrence part did it really happen was there a payment um to invoices or contracts and also proof of the funds transfer i'm going to assume here that we have lx electronic funds transfer we're not actually sending physical checks we just don't do that here in australia you might do that in some other countries but hopefully everybody's moving to electronic banking at the moment not a great idea to be handling lots of things now completeness is have we recorded all of our payments so again we're worried about under reporting so if we're picking things to be at risk completeness and accuracy there is going to be the under reporting issues that we need to think about so here we're going to trace a sample maybe let's say a haphazard sample this time neither is better than the other really haphazard sample of lease contracts to funds transfer and journal entries again so we had to make a payment payment was made journal entry for the payment was made trace it through time following our footsteps now remember accuracy is all about the dollars so while tracing and vouching and we should do this either way right because we take attack the the transactions from both ends while tracing and vouching uh match the payment to the journal entry uh oh hang on maybe match the amount of the payment to the journal entry so again dollar value is correct we might also potentially recalculate the payment so if there is some sort of formula about how the repayment is calculated you might recalculate it do the formula again yourself to make sure that that amount is correct match them out to the journal of payment to journal entry and the contract as well we want to make sure that we're paying the amount on the contract that might need to be indexed by cpi or something but usually there's a table that says like these periods here is the payment these periods here is the payment all right classification this is about remember journal entries the journals being recorded correctly so while tracing check that the journal entry uses the correct account code from the chart of accounts and sometimes you might see chart of accounts as coa so remember coa is the full list of every single account code um and you know every leased asset you have will have its own account code so we're making sure those journal entries are doing are being done correctly and we have to do that while we're tracing while we're moving forwards because if i start with vouching i'm never going to find incorrect journal entries because i'm always looking in where they should be and we're not looking where they shouldn't be all right cut off cutoff is about recording things in the correct period so here let's uh select a block sample of payments let's say two weeks two weeks before and after the end of the financial year okay um ensure that the journal entry is recorded in the same period that the payment is made oops the payment is made now that is really important because if you pay on the 30th of june then you want it to be recorded in the 30th of june and not in the future period now the other thing that we haven't talked about yet is the presentation assertion which is really all about the disclosures there so that's about our note disclosures and making sure that our note disclosures are in line with ifres16 or if you're in australia double asb 116. um so we're going to need to review those notes check the standard and make sure that what the standard says they're supposed to do is actually what they've done so you're going to do a lot of inspecting and checking there now of course if you get stuck on this and you go i'm not sure if they're disclosing the right information go and talk to an expert within your firm there will be somebody who specializes in reporting of leases for example or there'll be an ifra16 specialist that you can ask to say look does this look right are they doing this correctly phew all right so that is everything in our procedures for testing controls and substantive testing but it's not exhaustive so if you have an idea on how we could test substantively or control for leases liability the payment um the asset then definitely please share those with our little audit community we're growing and growing uh every single week in the comments of course if you haven't already i'd love for you to subscribe i have lots of new videos coming out every single week and also i'm on all of the social so you can follow me on instagram on facebook on twitter as well but thanks for watching stay safe stay well and i'll see you next time