Audit season has a way of putting every assumption and calculation under a microscope, and lease accounting under IFRS 16 is no exception. Since the standard requires detailed present value calculations, ongoing reassessments, and specific disclosures, auditors tend to focus closely on this area.
Knowing what auditors typically look for can help your finance team prepare in advance, rather than scrambling to justify numbers after the fact. Here is a breakdown of the key areas auditors usually examine.
Completeness of the Lease Population
Before looking at any calculations, auditors want assurance that all leases have actually been identified and included. This means reviewing contracts across the business, not just obvious rental agreements, to check whether any arrangements meet the definition of a lease under IFRS 16.
Auditors often test this by reviewing contracts, purchase orders, or expense accounts to see if there are lease like arrangements that were missed. If a lease is left out of the population, everything else in the calculation becomes irrelevant for that agreement.
Appropriateness of the Discount Rate
The discount rate used to calculate the present value of lease payments is one of the most scrutinized inputs. Auditors will ask how the rate was determined, whether it reflects the specific lease term and currency, and whether the methodology has been applied consistently across similar leases.
If your business uses the incremental borrowing rate rather than the interest rate implicit in the lease, expect auditors to request documentation showing how that rate was derived, including any supporting data or assumptions used.
Accuracy of Lease Term Assumptions
The lease term used in calculations should reflect the non-cancellable period of the lease, along with any renewal options that are reasonably certain to be exercised, or termination options that are reasonably certain not to be exercised.
Auditors will examine whether the judgment applied to these assumptions is reasonable and consistently applied. If a business assumes a renewal option will be exercised without clear supporting reasoning, this is likely to be questioned.
Proper Treatment of Variable Lease Payments
Since variable payments are treated differently depending on whether they are linked to an index or rate versus usage or sales, auditors will check that each type of variable payment has been classified and accounted for correctly.
Misclassifying these payments is a common area of error, so having clear documentation showing how each variable payment clause was analyzed and treated will make this part of the audit process much smoother.
Recalculations for Modifications and Reassessments
Lease modifications, such as extensions, reduced space, or changed payment terms, require the lease liability and right of use asset to be recalculated. Auditors will check whether these recalculations were performed correctly and on time whenever a modification occurred during the reporting period.
They will also look at whether reassessment triggers, such as changes in the likelihood of exercising a renewal option, were properly identified and accounted for.
Application of Exemptions
For short term leases and low value asset leases, auditors will verify that the exemptions applied were appropriate. This means checking that short term leases genuinely have a lease term of 12 months or less, and that low value assets meet the criteria intended by the standard, which generally applies to assets of low value when new, rather than assets that happen to have a low remaining value.
Disclosure Completeness
Beyond the calculations themselves, IFRS 16 requires specific disclosures in the financial statements, including information about right of use assets, lease liabilities, and the nature of the lessee’s leasing activities. Auditors will review whether these disclosures are complete and consistent with the underlying calculations.
Missing or inconsistent disclosures can raise red flags, even if the underlying calculations are accurate, so this is worth reviewing carefully before the audit begins.
How to Prepare in Advance
The best way to handle an IFRS 16 audit smoothly is to maintain clear documentation throughout the year, not just at reporting time. This includes keeping records of lease contracts, discount rate methodology, judgment calls on lease terms, and any modifications as they happen.
Having this information organized and accessible before the audit begins can significantly reduce the back and forth that often slows down the process.
FAQs
FAQ 1. What do auditors check first when reviewing IFRS 16 lease accounting?
Auditors typically start by confirming the completeness of the lease population, making sure all qualifying leases have been identified and included in the calculations.
FAQ 2. Why is the discount rate such a major focus during audits?
The discount rate directly affects the value of the lease liability and right of use asset, so auditors want to confirm the rate was determined using a consistent and well supported methodology.
FAQ 3. What documentation should finance teams keep ready for an IFRS 16 audit?
Useful documentation includes lease contracts, discount rate assumptions, judgment on lease term and renewal options, records of any lease modifications, and the reasoning behind any exemptions applied.
Final Thoughts
Auditors are not looking to catch businesses off guard. They simply want confidence that the lease accounting figures presented are accurate, well supported, and consistently applied. By understanding what auditors typically focus on and preparing documentation throughout the year rather than at the last minute, finance teams can approach audit season with far less stress.
