Thinking Challenge 2

Accountancy 4400: Financial Statement Auditing Instructor: Dr. David L. Senteney Ph.D. CPA CGMA

Spring 2021 Department of Accountancy

Auditing Logistical Logistics Inc. Handout 2: Auditing Logistical Logistics — Internal Control Matrix — Lease Process

Control No. Control Title Control Description L 1 Contract Review —

Contract database is reviewed by each department leader.

On a quarterly basis, each department leader (e.g., Sales, Treasury, Human Resources, IT, Tax), with appropriate knowledge of the contracts entered into by his or her department, reviews the database to verify that (1) all contracts (i.e., new, existing, or modified), in accordance with the entity’s accounting policies, have been included in the database and (2) all events or circumstances requiring reassessment have been identified. Each department leader provides representation to the Lease Accountant of the completeness and accuracy of the database, as well as, the contracts identified that require reassessment to the best of his or her knowledge.

L 2 Lease Terms Review — Controller reviews and approves the key contract terms entered into the lease software.

The Controller, with appropriate knowledge of the entity’s lease arrangements and the accounting framework and principles under the requirements of ASC 842, reviews the contract listing (e.g., contract database extract) to verify that all the key contract terms for the entity’s lease arrangements were entered by the Lease Accountant into the lease software. The Controller will verify the completeness and accuracy of the contract listing (e.g., contract database extract) by reviewing key terms against the lease contracts. Any differences identified as a result of the Controller’s review are investigated and resolved, and all questions are addressed. The Controller then approves and signs off on the contract listing (e.g., contract database extract).

L 3 Review of Reconciliations — Controller reviews and approves all general ledger reconciliations for the lease specific accounts.

The Controller reviews the lease account balance reconciliations, on a quarterly basis, along with the detailed lease analysis supporting the amounts recorded, as prepared by the Lease Accountant. After performing the review, any differences identified as a result of the review are investigated and resolved, and all questions are addressed. The Controller then approves and signs off on the lease account balance reconciliations.

L 4 Lease Review — Controller reviews contract terms and

An analysis of the accounting conclusion memo for the contract is prepared by the Lease Accountant, who submits it (along with the contract) to the Controller, who has

approves the accounting conclusion memo.

appropriate knowledge of the entity’s lease arrangements and the accounting framework and principles under the requirements of ASC 842. The Controller reviews the contract to determine whether the contract is or contains a lease (or whether it is identified as a sale and leaseback transaction) and if so, the classification of such lease within the scope of ASC 842. The Controller’s review of each contract and accounting conclusion memo includes the following: Step 1— Read the relevant terms of the contract to determine whether the criteria for a contract to be accounted for as a lease under ASC 842 has been met.

a. The contract gives the customer the right to control the use of the identified property, plant, and equipment for a period in exchange for consideration. Control is considered to exist if the customer has both of the following: (1) the right to obtain substantially all of the economic benefits from use of an identified asset and (2) the right to direct the use of that asset.

b. A capacity portion of an asset is an identified asset if it is physically distinct. A capacity or other portion of an asset that is not physically distinct is not an identified asset, unless it represents substantially all of the capacity of the asset and thereby provides the customer with the right to obtain substantially all of the economic benefits from use of the asset.

The Controller also reviews the contract to determine whether each separate lease and nonlease component within the contract has been properly identified. Step 2 — Read the relevant terms of the contract to determine the classification of the lease as of the lease commencement date. This evaluation focuses on whether control of the underlying asset is effectively transferred to the lessee. A lease would be classified as a finance lease from the perspective of a lessee if any of the following criteria are met:

a. The lease transfers ownership of the underlying asset to the lessee by the end of the lease term.

b. The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise.

c. The lease term is for the major part of the remaining economic life of the underlying asset.

d. The present value of the sum of the lease payments and any residual value guaranteed by the lessee equals or exceeds substantially all of the fair value of the underlying asset.

e. The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.

Leases that do not meet any of these criteria (i.e., a lease in which the lessee does not effectively obtain control of the underlying asset) would be classified as operating leases by the lessee. Step 3 — Read the relevant terms of the contract for the proper identification of a sale and leaseback transaction, on the basis of whether the asset transfer represents a sale in accordance with ASC 842. If so, determine the appropriate classification of the leaseback transaction in accordance with ASC 842. After each review step is performed, any differences identified as a result of the review are investigated and resolved, and all questions are addressed. The Controller then approves and signs off on the accounting conclusion memo and submits all lease contracts to the Lease Accountant for entry into the lease software for calculating and accounting for the lease.

L 5 Journal Entry Approval — Controller reviews and approves the journal entries and supporting documentation.

The Controller reviews and approves the manual journal entries and supporting documentation prepared by the Lease Accountant. The Lease Accountant is responsible for posting the entries following the Controllers’ approval. Copies of each entry posted to the general ledger are retained, including supporting documentation. Any differences identified as a result of the Controller’s review are investigated and resolved, and all questions are addressed. The Controller then approves and signs off on the manual journal entries and documentation reviewed, which would include a detailed lease analysis with the relevant lease terms, discount rate and lease payments, as well as other supporting documentation.

L 6 Long-Lived Asset Impairment — Controller reviews and approves the quarterly

The Controller reviews the quarterly long-lived asset impairment memo, prepared by the Lease Accountant, to identify whether the carrying amount of any long-lived assets (including ROU assets) may not be recoverable (i.e., identification of triggering events) that would necessitate

long-lived asset impairment memo.

an undiscounted cash flow analysis. The quarterly long- lived asset impairment memo includes (1) a review of applicable U.S. GAAP guidance (ASC 360), (2) evaluation of present business and market conditions, and (3) a conclusion on whether a triggering event is present. Any differences identified as a result of the Controller’s review are investigated and resolved, and all questions are addressed. The Controller then approves by signing off on the long-lived asset impairment memo.