Auditing IFRS 16 Rights of Use Explained: When it comes to auditing leases, we first need to look at the process itself. So let us look at what that process looks like. Typically, there needs to be some sort of process to request a leased asset. You cannot just lease an asset yourself in a business, so there has to be some sort of approval for that request.
There will be a process to get quotes from different companies that will provide you with the leased asset. Once you get a quote, there will be a contract. It is very important that the contract is reviewed by a lawyer to make sure that it has been legally reviewed.
Then the parties have to sign the contract and we have to get the accounting in order, which means we have to record the event in the accounts. We suspect there are a few things we need to keep in mind when doing the accounting.
Auditing IFRS 16 Rights of Use Explained
Adding Assets
First, there needs to be a process to potentially add the asset to the asset register FA. Hopefully you know that most asset registers these days are able to recognize an asset that you own and one that you have leased, so you need to make sure that there is that component to add the asset to the asset register.
Create Liabilities
You need to make sure that you create the liability LLC, which is the lease liability. You also need to set up a process for your regular journal entries, and those regular journals are about payments because. Remember, you have to make the payments through the lease and also record the depreciation because it’s a leased asset that has its own liabilities. In terms of testing internal controls, this is where it’s really important that you understand the controls and processes that are in place so that you can test those controls.
ISA 315 is very important to understand the client. So, it comes down to setting the audit strategy. So if it’s a company with a lot of leased assets and a lot of new leases that you probably cannot audit all of them, as you would with bank loans, it probably makes sense to audit the internal controls and then do some more in-depth testing.
If the company has, say, 5 leased assets and has not entered into any new leases this year, then you would not even bother testing the internal controls, you’d go straight to the substantive evidence. But you know you have to consider the size of the transactions and the value of the transactions to decide whether you are going to use the tested controls strategy or the substantive evidence strategy or a mix of both.
Companies that need a large audit will likely consider both aspects and use a mix of control testing and substantive testing. This is where we need to look at what your client’s process is under ISA 315 so that we can identify controls. So you know we will look at the approval process for example, for leased assets.
Accounting Procedures
You are probably going to spend more time looking at accounting procedures and controls related to accounting than controls related to the general leasing process. For example, if you need to include an asset in the asset register, you create the liability. You probably need to set up a process where you review leased assets from fixed assets.
Depreciation
Depreciation is then applied to the right of use of the asset. In general, depreciation occurs over the shorter of the asset’s useful life and the lease term, unless the asset is transferred at the end of the lease term, when it is depreciated over its useful life.
Accounting for Leases
One floor of a building is leased for 20 years with an option to extend for an additional five years. In the initial period, lease payments are $80,000 per year, and during the optional period, they are $100,000 per year. Initial direct costs of $25,000 were incurred by the lessee to secure the lease
Since the lessee was not reasonably certain that it would exercise the option to extend the lease, the lease term was set at 20 years at lease commencement. Interest is charged annually at a rate of 6%. This amounts to $917,600 in lease payments.
Lease liability is determined at $917,600 when the lessee incurs the first direct costs. Based on these entries, the right of use asset has a carrying amount of $942,600 which is the sum of $917,600 and $25,000. Due to this, the depreciation expense will be $47,130 which is $942,600 multiplied by 1/20).
Subsequent Measurement of The Right-Of-Use Asset
Lessors are required to measure rights-of-use assets at cost unless they apply the fair value model under IAS 40 or revaluation model under IAS 16
Elements Of Cost
An asset recorded as right-of-use is initially valued at its cost (determined above) less any accumulated depreciation and impairment losses (IFRS 16.30). In addition, any reassessment or modification that results in a reappraisal of the lease liability will affect the cost.
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